401K Plan Setup

401(k) Glossary of Terms Whether you're offering a 401(k) for the first time or need a refresh on important terms, these definitions can help you make sense of industry jargon. 3(16) fiduciary: A fiduciary partner hired by an employer to handle a plan’s day-to-day administrative responsibilities and ensure that the plan remains in compliance with Department of Labor regulations. 3(21) fiduciary: An investment advisor who acts as co-fiduciary to review and make recommendations regarding a plan’s investment lineup. This fiduciary provides guidance but does not have the authority to make investment decisions. 3(38) fiduciary: A codified retirement plan fiduciary that’s responsible for choosing, managing, and overseeing the plan’s investment options. 401(k) administration costs: The expenses involved with the various aspects of running a 401(k) plan. Plan administration includes managing eligibility and enrollment, coordinating contributions, processing distributions and loans, preparing and delivering legally required notices and forms, and more. 401(k) committee charter: A document that describes the 401(k) committee’s responsibilities and authority. 401(k) compensation limit: The maximum amount of compensation that’s eligible to draw on for plan contributions, as determined by the IRS. In 2020, this limit is $285,000. Keep in mind that contributions are also limited by the 401(k) contribution limit, which is $19,500 in 2020 for those under age 50. 401(k) contribution limits: The maximum amount that a participant may contribute to an employer-sponsored 401(k) plan, as determined by the IRS. For 2020, the limits are $19,500 for individuals under age 50, and $26,000 for individuals age 50 and older (including $6,500 in catch-up contributions). 401(k) force-out rule: Refers to a plan sponsor’s option to remove a former employee’s assets from the retirement plan. The sponsor has the option to “force out” these assets (into an IRA in the former employee’s name) if the assets are less than $5,000. 401(k) plan: An employer-sponsored retirement savings plan that allows participants to save money on a tax-advantaged basis. 401(k) plan fees: The various fees associated with a plan. These can include fees for investment management, plan administration, fiduciary services, and consulting fees. While some fees are applied at the plan level — that is, deducted from plan assets — others are charged directly to participant accounts. 401(k) plan fee benchmarking: The process of comparing a plan’s fees to those of other plans in similar industries with roughly equal assets and participation rates. This practice can help to determine if a plan’s fees are reasonable per ERISA requirements. 401(k) set-up costs: The expenses involved in establishing a 401(k) plan. These costs cover plan documents, recordkeeping, investment management, participant communication, and other essential aspects of the plan. 401(k) withdrawal: A distribution from a plan account. Because a 401(k) plan is designed to provide income during retirement, a participant generally may not make a withdrawal until age 59 ½ unless he or she terminates or retires; becomes disabled; or qualifies for a hardship withdrawal per IRS rules. Any other withdrawals before age 59 ½ are subject to a 10% penalty as well as regular income tax. 404(a)(5) fee disclosure: A notice issued by a plan sponsor that details information about investment fees. This notice, which is required of all plan sponsors by the Department of Labor, covers initial disclosure for new participants, new fees, and fee changes. 404(c) compliance: Refers to a participant’s (or beneficiary’s) right to choose the specific investments for 401(k) plan assets. Because the participant controls investment decisions, the plan fiduciary is not liable for investment losses. 408(b)(2) fee disclosure: A notice issued by a plan service provider that details the fees charged by the provider (and its affiliates or subcontractors) and reports any possible conflicts of interest. The Department of Labor requires all plan fiduciaries to issue this disclosure. Actual contribution percentage (ACP) test: A required compliance test that compares company matching contributions among highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). Actual deferral percentage (ADP) test: A required compliance test that compares employee deferrals among highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). Annual fee disclosure: A notice issued by a plan sponsor that details the plan’s fees and investments. This disclosure includes plan and individual fees that may be deducted from participant accounts, as well as information about the plan’s investments (performance, expenses, fees, and any applicable trade restrictions). Automated Clearing House (ACH): A banking network used to transfer funds between banks quickly and cost-efficiently. Automatic enrollment (ACA): An option that allows employers to automatically deduct elective deferrals into the plan from an employee’s wages unless the employee actively elects not to contribute or to contribute a different amount. Beneficiary: The person or persons who a participant chooses to receive the assets in a plan account if he or she dies. If the participant is married, the spouse is automatically the beneficiary unless the participant designates a different beneficiary (and signs a written waiver). If the participant is not married, the account will be paid to his or her estate if no beneficiary is on file. Blackout notice: An advance notice of an upcoming blackout period. ERISA rules require plan sponsors to notify participants of a blackout period at least 30 days in advance. Blackout period: A temporary period (three or more business days) during which a 401(k) plan is suspended, usually to accommodate a change in plan administrators. During this period, participants may not change investment options, make contributions or withdrawals, or request loans. Catch-up contributions: Contributions beyond the ordinary contribution limit, which are permitted to help people age 50 and older save more as they approach retirement. In 2022, contribution limits (set by the IRS) are $20,500 on ordinary contributions and $6,500 on catch-up contributions, for a combined limit of $27,000. Compensation: The amount of pay a participant receives from an employer. For purposes of 401(k) contribution calculations, only compensation is considered to be eligible. The plan document defines which form, for example the W-2, is referred to in determining the compensation amount. Constructive receipt: A payroll term that refers to the impending receipt of a paycheck. The paycheck has not yet been fully cleared for deposit in the employee’s bank account, but the employee has access to the funds. Deferrals: Another term for contributions made to a 401(k) account. Defined contribution plan: A tax-deferred retirement plan in which an employee or employer (or both) invest a fixed amount or percentage (of pay) in an account in the employee’s name. Participation in this type of plan is voluntary for the employee. A 401(k) plan is one type of tax-deferred defined contribution plan. Department of Labor (DOL): The federal government department that oversees employer-sponsored retirement plans as well as work-related issues including wages, hours worked, workplace safety, and unemployment and reemployment services. Distributions: A blanket term for any withdrawal from a 401(k) account. A distribution can include a required minimum distribution (RMD), a loan, a hardship withdrawal, a residential loan, or a qualified domestic relations order (QDRO). Docusign: A third-party platform used for exchanging signatures on documents, especially during plan onboarding. EIN: An Employer Identification Number (EIN) is also known as a Federal Tax Identification Number, and is used to identify a business entity. Eligible automatic enrollment arrangement (EACA): An automatic enrollment (ACA) plan that applies a default and uniform deferral percentage to all employees who do not opt out of the plan or provide any specific instructions about deferrals to the plan. Under this arrangement, the employer is required to provide employees with adequate notice about the plan and their rights regarding contributions and withdrawals. ERISA: Refers to the Employee Retirement Income Security Act of 1974, a federal law that requires individuals and entities that manage a retirement plan (fiduciaries) to follow strict standards of conduct. ERISA rules are designed to protect retirement plan participants and secure their access to benefits in the plan. Excess contributions: The amount of contributions to a plan that exceed the IRS contribution limit. Excess contributions made in any year (and their earnings) may be withdrawn without penalty by the tax filing deadline for that year, and the participant is then required to pay regular taxes on the amount withdrawn. Any excess contributions not withdrawn by the tax deadline are subject to a 6% excise tax every year they remain in the account. Exchange-traded fund (ETF): Passively managed index funds that feature low costs and high liquidity. ETFs make it easy to manage portfolios efficiently and effectively. All of Betterment’s 401(k) investment options are ETFs. Fee disclosure: Information about the various fees related to a 401(k) plan, including plan administration, fiduciary services, and investment management. Fee disclosure deadline: The date by which a plan sponsor must provide plan and investment-related fee disclosure information to participants. The DOL requires you to send your participant fee disclosure notice at least once in any 14-month period without regard to whether the plan operates on a calendar-year or fiscal-year basis. Fidelity bond: Also known as a fiduciary bond, this bond protects the plan from losses due to fraud or dishonesty. Every fiduciary who handles 401(k) plan funds is required to hold a fidelity bond. Fiduciary: An individual or entity that manages a retirement plan and is required to always act in the best interests of employees who save in the plan. In exchange for helping employees build retirement savings, employers and employees receive special tax benefits, as outlined in the Internal Revenue Code. When a company adopts a 401(k) plan for employees, it becomes an ERISA fiduciary and takes on two sets of fiduciary responsibilities: “Named fiduciary” with overall responsibility for the plan, including selecting and monitoring plan investments “Plan administrator” with fiduciary authority and discretion over how the plan is operated Most companies hire one or more outside experts (such as an investment advisor, investment manager, or third-party administrator) to help manage their fiduciary responsibilities. Form 5500: An informational document that a plan sponsor must prepare to disclose the identity of the plan sponsor (including EIN and plan number), characteristics of the plan (including auto-enrollment, matching contributions, profit-sharing, and other information), the numbers of eligible and active employees, plan assets, and fees. The plan sponsor must submit this form annually to the IRS and the Department of Labor, and must provide a summary to plan participants. Smaller plans (less than 100 employees) may instead file Form 5500-SF. Hardship withdrawal: A withdrawal before age 59 ½ intended to address a severe and immediate need (as defined by the IRS). To qualify for a hardship withdrawal, a participant must provide the employer with documentation (such as a medical bill, a rent invoice, funeral expenses) that shows the purpose and amount needed. If the hardship withdrawal is authorized, it must be limited to the amount needed (adjusted for taxes and penalties), may still be subject to early withdrawal penalties, is not eligible for rollover, and may not be repaid to the plan. Highly compensated employee (HCE): An employee who earned at least $125,000 in compensation from the plan sponsor during the previous year (if 2019), or at least $130,000 if the previous year is 2020, or owned more than 5% interest in the plan sponsor’s business at any time during the current or previous year (regardless of compensation). Inception to date (ITD): Refers to contribution amounts since the inception of a participant’s account. Internal Revenue Service (IRS): The U.S. federal agency that’s responsible for the collection of taxes and enforcement of tax laws. Most of the work of the IRS involves income taxes, both corporate and individual. Investment advice (ERISA ruling): The Department of Labor’s final ruling (revised in 2020) on what constitutes investment advice and what activities define the role of a fiduciary. Investment policy statement (IPS): A plan’s unique governing document, which details the characteristics of the plan and assists the plan sponsor in complying with ERISA requirements. The IPS should be written carefully, reviewed regularly, updated as needed, and adhered to closely. Key employee: An employee classification used in top-heavy testing. This is an employee who meets one of the following criteria: Ownership stake greater than 5% Ownership stake greater than 1% and annual compensation greater than $150,000 Officer with annual compensation greater than $200,000 (for 2022) Non-discrimination testing: Tests required by the IRS to ensure that a plan does not favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). Non-elective contribution: An employer contribution to an employee’s plan account that’s made regardless of whether the employee makes a contribution. This type of contribution is not deducted from the employee’s paycheck. Non-highly compensated employee (NHCE): An employee who does not meet any of the criteria of a highly compensated employee (HCE). Plan sponsor: An organization that establishes and offers a 401(k) plan for its employees or members. Qualified default investment alternative (QDIA): The default investment for plan participants who don’t make an active investment selection. All 401(k) plans are required to have a QDIA. For Betterment’s 401(k), the QDIA is the Core Portfolio Strategy, and a customized risk level is set for each participant based on their age. Qualified domestic relations order (QDRO): A document that recognizes a spouse’s, former spouse’s, child’s, or dependent’s right to receive benefits from a participant’s retirement plan. Typically approved by a court judge, this document states how an account must be split or reassigned. Plan administrator: An individual or company responsible for the day-to-day responsibilities of 401(k) plan administration. Among the responsibilities of a plan administrator are compliance testing, maintenance of the plan document, and preparation of the Form 5500. Many of these responsibilities may be handled by the plan provider or a third-party administrator (TPA). Plan document: A document that describes a plan’s features and procedures. Specifically, this document identifies the type of plan, how it operates, and how it addresses the company’s unique needs and goals. Professional employer organization (PEO): A firm that provides small to medium-sized businesses with benefits-related and compliance-related services. Profit sharing: A type of defined contribution plan in which a plan sponsor contributes a portion of the company’s quarterly or annual profit to employee retirement accounts. This type of plan is often combined with an employer-sponsored retirement plan. Promissory note: A legal document that lays out the terms of a 401(k) loan or other financial obligation. Qualified non-elective contribution (QNEC): A contribution that a plan is required to make if it’s found to be top-heavy. Required minimum distribution (RMD): Refers to the requirement that an owner of a tax-deferred account begin making plan withdrawals each year starting at age 72. The first withdrawal must be made by April 1 of the year after the participant reaches age 72, and all subsequent annual withdrawals must be made by December 31. Rollover: A retirement account balance that is transferred directly from a previous employer’s qualified plan to the participant’s current plan. Consolidating accounts in this way can make it easier for a participant to manage and track retirement investments, and may also reduce retirement account fees. Roth 401(k) contributions: After-tax plan contributions that do not reduce taxable income. Contributions and their earnings are not taxed upon withdrawal as long as the participant is at least age 59½ and has owned the Roth 401(k) account for at least five years. For 2020, the limits on plan contributions (Traditional, Roth, or a combination of both) are $19,500 for individuals under age 50, and $26,000 for individuals age 50 and older (including $6,500 in catch-up contributions). Roth vs. pre-tax contributions: Pre-tax contributions reduce a participant’s current income, with taxes due when funds are withdrawn (typically in retirement). Alternatively, Roth contributions are deposited into the plan after taxes are deducted, so withdrawals are tax-free. Safe Harbor: A plan design option that provides annual testing exemptions. In exchange, employer contributions on behalf of all employees are required. Saver’s credit: A credit designed to help low- and moderate-income taxpayers further reduce their taxes by saving for retirement. The amount of this credit — 10%, 20%, or 50% of contributions, based on filing status and adjusted gross income — directly reduces the amount of tax owed. Stock option: The opportunity for an employee to purchase shares of an employer’s stock at a specific (often discounted) price for a limited time period. Some companies may offer a stock option as an alternative or a complement to a 401(k) plan. Summary Annual Report (SAR): A summary version of Form 5500, which a plan sponsor is required to provide to participants every year within two months after the Form 5500 deadline – September 30 or December 15 (if there was an extension given for Form 5500 filing). Summary Plan Description (SPD): A comprehensive document that describes in detail how a 401(k) plan works and the benefits it provides. Employers are required to provide an SPD to employees free of charge. Third-party administrator (TPA): An individual or company that may be hired by a 401(k) plan sponsor to help run many day-to-day aspects of a retirement plan. Among the responsibilities of a TPA are compliance testing, generation and maintenance of the plan document, and preparation of Form 5500. Traditional contributions: Pre-tax plan contributions that reduce taxable income. These contributions and their earnings are taxable upon withdrawal, which is typically during retirement. Vesting: Another word for ownership. Participants are always fully vested in the contributions they make. Employer contributions, however, may be subject to a vesting schedule in which participant ownership builds gradually over several years.

Understanding your 401(k) Plan Document Betterment will draft your 401(k) plan document, but it’s important that you understand what it includes and that you follow it as written. What exactly is a Plan Document? A 401(k) plan is considered a qualified retirement plan by the Internal Revenue Service (IRS), and as such, must meet certain requirements to take advantage of significant tax benefits. Every 401(k) retirement plan is required to have a plan document that outlines how the plan is to be operated. The plan document should reflect your organization’s objectives in sponsoring the 401(k) plan, including information such as plan eligibility requirements, contribution formulas, vesting requirements, loan provisions, and distribution requirements. As regulations change or your organization changes plan features and/or rules, the plan document will need to be amended. Your provider will likely draft your plan’s document, but because of your fiduciary duty, it is important that you as plan sponsor review your plan document, understand it, and refer to it if questions arise. Whether you are a small business or a large corporation, failure to operate the plan in a manner consistent with the document as written can result in penalties from the IRS and/or the Department of Labor (DOL). Understanding Your Fiduciary Responsibilities Although any given 401(k) plan may have multiple (and multiple types of) fiduciaries based on specific plan functions, the plan document identifies the plan’s “Named Fiduciary” who holds the ultimate authority over the plan and is responsible for the plan’s operations, administration and investments. Typically the employer as plan sponsor is the Named Fiduciary. The employer is also the “plan administrator” with responsibility for overall plan governance. While certain fiduciary responsibilities may be delegated to third parties, fiduciary responsibility can never be fully eliminated or transferred. All fiduciaries are subject to the five cornerstone rules of ERISA (Employee Retirement Income Security Act) when managing the plan’s investments and making decisions regarding plan operations: Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them; Carrying out their duties prudently; Following the plan documents (unless inconsistent with ERISA); Diversifying plan investments; and Paying only reasonable plan expenses. One of the best ways to demonstrate that you have fulfilled your fiduciary responsibilities is to document your decision-making processes. Many plan sponsors establish a formal 401(k) plan committee to help ensure that decisions are appropriately discussed and documented. Which Type of 401(k) Plan is Best for Your Organization? The plan document will identify the basic plan type: Traditional 401(k) plans provide maximum flexibility with respect to employer contributions and associated vesting schedules (defining when those contributions become owned by the employee). However, these plans are subject to annual nondiscrimination testing to ensure that the plan benefits all employees—not just business owners or highly compensated employees (HCEs). Safe Harbor 401(k) plans are deemed to pass certain nondiscrimination tests but require employers to contribute to the plan on behalf of employees. This mandatory employer contribution must vest immediately—rather than on a graded or cliff vesting schedule. QACA Safe Harbor plans are an exception, which may have up to a two-year cliff vesting schedule. Profit-sharing 401(k) plans include an additional component that allows employers to make more significant contributions to their employee accounts. Besides helping to attract and retain talent, small businesses can find this feature especially helpful In highly profitable years, since it reduces taxable income. There is no one plan type that is better than another, but this flexibility allows you to determine which type makes the most sense for your organization. Eligibility Requirements to Meet Your Needs Although the IRS mandates that employees age 21 or older with at least 1 year of service are eligible to make employee deferrals, employers do have considerable flexibility in setting 401(k) plan eligibility: Age -- employers often choose to adopt a minimum age of 18. Service -- employers can establish requirements on elapsed time or hours. Entry date -- employers may allow employees to participate in the plan immediately upon hiring but often require some waiting period. For example, employees may have to wait until the first of the month or quarter following their hire date. This flexibility allows employers to adopt eligibility requirements appropriate to their business needs. For instance, a company with high turnover or lots of seasonal workers may institute a waiting period to reduce the number of small balance accounts and the associated administrative costs. Automatic Enrollment may be the Way to Go Enrollment in a 401(k) plan can either be voluntary or automatic. As retirement savings has become ever more essential for workers, employers are increasingly choosing to adopt automatic enrollment, whereby a set percentage is automatically deferred from employee paychecks and contributed to the plan, unless an employee explicitly elects to “opt out” or not contribute. The benefit of automatic enrollment is that human inertia means most employees take no action and start saving for their future. As of September 2022, only 13% of participants who were auto-enrolled opted out per Betterment’s internal analysis. Employee Contribution Flexibility Provides Valuable Flexibility The plan document will specify the types of contributions (or “elective deferrals”) that eligible employees can make to the plan via payroll deduction. Typically these will be either pre-tax contributions or Roth (made with after-tax dollars) contributions. Allowing plan participants to decide when to pay the taxes on their contributions can provide meaningful flexibility and tax diversification benefits. Elective deferrals are often expressed as either a flat dollar amount or as a percentage of compensation. Employee contribution limits are determined each year by the IRS. The plan document must specify whether the plan will allow catch-up contributions for those age 50 and older. Able and/or Willing to Contribute to Employee Accounts? The plan document will also include provisions regarding employer contributions, which can be made on either a matching or non-matching basis. Matching contributions are often used to incentivize employees to participate in the plan. For example, an employer may match 50% of every $1 an employee contributes, up to a maximum of 6% of compensation. For traditional 401(k) plans, matching contributions can be discretionary so that the employer can determine not only how much to contribute in any given year but whether or not to contribute at all. As stated above, matching employer contributions are required for Safe Harbor 401(k) plans. The plan document may also permit the employer to make contributions other than matching contributions. These so-called “nonelective” contributions would be made on behalf of all employees who are considered plan participants, regardless of whether they are actively contributing. Vesting Schedules and Employee Retention Vesting simply means ownership. Employees own, or are fully vested, in their own contributions at all times. Employers with traditional 401(k) plans, however, often impose a vesting schedule on company contributions to encourage employee retention. Although there are a wide variety of approaches to vesting, one of the most common is to use a graded vesting schedule. For instance, an employee would vest in the employer contribution at a rate of 25% each year and be 100% vested after 4 years. Employer contributions as part of Safe Harbor 401(k) plans are vested immediately, aside from QACA Safe Harbor plans. Let Betterment help you create a 401(k) that works for you and your employees As a full-service provider, Betterment aims to make life easy for you. We will draft your plan document based on your preferences and our industry expertise of best practices. We will work with you to keep your plan in compliance and can prepare amendments based on your changing needs. Sign up for a free demo to learn about the impact our 401(k) plan can have on your business.