Contributing

All About Vesting of Employer Contributions Employers have flexibility in defining their plan’s vesting schedule, which can be an important employee retention tool. Regardless of age, employees (as well as job seekers), are thinking about saving for their future. 401(k) plans, therefore, are a very attractive benefit and can be an important competitive tool in helping employers attract and retain talent. And when a company sweetens the 401(k) plan with a matching or profit sharing contribution, that’s like “free money” that can be hard for prospective and current employees to pass up. But with employer contributions comes the concept of “vesting,” which both employees and employers should understand. What is Vesting? With respect to retirement plans, “vesting” simply means ownership. In other words, each employee will vest, or own, a portion or all of their account in the plan based on the plan’s vesting schedule. All 401(k) contributions that an employee makes to the plan, including pre-tax and/or Roth contributions made through payroll deduction, are immediately 100% vested. Those contributions were money earned by the employee as compensation, and so they are owned by the employee immediately and completely. Employer contributions made to the plan, however, usually vest according to a plan-specific schedule (called a vesting schedule) which may require the employee to work a certain period of time to be fully vested or “own” those funds. Often ownership in employer contributions is made gradually over a number of years, which can be an effective retention tool by encouraging employees to stay long enough to vest in 100% of their employer contributions. What is a 401(k) Vesting Schedule? The 401(k) vesting schedule is the set of rules outlining how much and when employees are entitled to (some or all of)  the employer contributions made to their accounts. Typically, the more years of service, the higher the vesting percentage. Different Types of 401(k) Vesting Schedules Employers have flexibility in determining the type and length of vesting schedule. The three types of vesting are: Immediate Vesting - This is very straight-forward in that the employee is immediately vested (or owns) 100% of employer contributions from the point of receipt. In this case, employees are not required to work a certain number of years to claim ownership of the employer contribution. An employee who was hired in the beginning of the month and received an employer matching contribution in his 401(k) account at the end of the month could leave the company the next day, along with the total amount in his account (employee plus employer contributions). Graded Vesting Schedule - Probably the most common schedule, vesting takes place in a gradual manner. At least 20% of the employer contributions must vest after two years of service and 100% vesting can be achieved after anywhere from two to six years to achieve 100% vesting. Popular graded vesting schedules include:   3-Year Graded 4-Year Graded 5-Year Graded 6-Year Graded Yrs of Service % Vested % Vested % Vested % Vested 0 - 1 33% 25% 20% 0% 1 - 2 66% 50% 40% 20% 2 - 3 100% 75% 60% 40% 3 - 4   100% 80% 60% 4 - 5     100% 80% 5 - 6       100% Cliff Vesting Schedule - With a cliff vesting schedule, the entire employer contribution becomes 100% vested all at once, after a specific period of time. For example, if the company has a 3 year cliff vesting schedule and an employee leaves for a new job after two years, the employee would only be able to take the contributions they made to their 401(k) account; they wouldn’t have any ownership rights to any employer contributions that had been made on their behalf. The maximum number of years for a cliff schedule is 3 years. Popular cliff vesting schedules include:   2-Year Cliff 3-Year Cliff Yrs of Service % Vested % Vested 0 - 1 0% 0% 1 - 2 100% 0% 2 - 3   100% Frequently Asked Questions about Vesting What is a typical vesting schedule? Vesting schedules can vary for every plan. However, the most common type of vesting schedule is the graded schedule, where the employee will gradually vest over time depending on the years of service required. Can we change our plan’s vesting schedule in the future? Yes, with a word of caution. In order to apply to all employees, the vesting schedule can change only to one that is equally or more generous than the existing vesting schedule. Known as the anti-cutback rule, this prevents plan sponsors from taking away benefits that have already accrued to employees. For example, if a plan has a 4-year graded vesting schedule, it could not be amended to a 5- or 6-year graded vesting schedule (unless the plan is willing to maintain separate vesting schedules for new hires versus existing employees). The same plan could, however, amend its vesting schedule to a 3-year graded one, since the new benefit would be more generous than the previous one. Since my plan doesn't currently offer employer contributions, I don't need to worry about defining a vesting schedule, right? Whether or not your organization plans on making 401(k) employer contributions, for maximum flexibility, we recommend that all plans include provisions for discretionary employer contributions and a more restrictive vesting formula. The discretionary provision in no way obligates the employer to make contributions (the employer could decide each year whether to contribute or not, and how much). In addition, having a restrictive vesting schedule means that the vesting schedule could be amended easily in the future. When does a vesting period begin? Usually, a vesting period begins when an employee is hired so that even if the 401(k) plan is established years after an employee has started working at the company, all of the year(s) of service prior to the plan’s establishment will be counted towards their vesting. However, this is not always the case. The plan document may have been written such that the vesting period starts only after the plan has been in effect. This means that if an employee was hired prior to a 401(k) plan being established, the year(s) of service prior to the plan’s effective date will not be counted. What are the methods of counting service for vesting? Service for vesting can be calculated in two ways: hours of service or elapsed time. With the hours of service method, an employer can define 1,000 hours of service as a year of service so that an employee can earn a year of vesting service in as little as five or six months (assuming 190 hours worked per month). The employer must be diligent in tracking the hours worked to make sure vesting is calculated correctly for each employee and to avoid over-forfeiting or over-distributing employer contributions. The challenges of tracking hours of service often lead employers to favor the elapsed time method. With this method, a year of vesting is calculated based on years from the employee’s date of hire. If an employee is still active 12 months from their date of hire, then they will be credited with one year of service toward vesting, regardless of the hours or days worked at the company. If there is an eligibility requirement to be a part of the plan, does vesting start after an employee becomes an eligible participant in the plan? Typically, no, but it is dependent on what has been written into the plan document. As stated previously, the vesting clock usually starts ticking when the employee is hired. An employee may not be able to join the plan because there’s a separate eligibility requirement that must be met (for example, 6 months of service), but the eligibility computation period is completely separate from the vesting period. The only instance where an ineligible participant may not start vesting from their date of hire is if the plan document excludes years of service of an employee who has not reached the age of 18. How long does an employer have to deposit employer contributions to the 401(k) plan? This is dependent on how the plan document is written. If the plan document is written for employer contributions to be made every pay period, then the plan sponsor must follow their fiduciary duty to make sure that the employer contribution is made on time. If the plan document is written so that the contribution can be made on an annual basis, then the employer can wait until the end of the year ( or even until the plan goes through their annual compliance testing) to wait for the contribution calculations to be received from their provider. What happens to an employer contribution that is not vested? If an employee leaves the company before they are fully vested, then the unvested portion (including associated earnings) will be “forfeited” and returned to the employer’s plan cash account, which can be used to fund future employer contributions or pay for plan expenses. For example, if a 401(k) plan has a 6-year graded vesting schedule and an employee terminates service after only 5 years,  80% of the employer contribution will belong to the employee, and the remaining 20% will be sent back to the employer when the employee initiates a distribution of their account.

Share the Wealth: Everything you need to know about profit sharing 401(k) plans In addition to bonuses, raises, and extra perks, many employers elect to add profit sharing to their 401(k) plan. Read on for answers to frequently asked questions. Has your company had a successful year? A great way to motivate employees to keep up the good work is by sharing the wealth. In addition to bonuses, raises, and extra perks, many employers elect to add profit sharing to their 401(k) plan. Wondering if it might be right for your business? Read on for answers to frequently asked questions about profit sharing 401(k) plans. What is profit sharing? Let’s start with the basics. Profit sharing is a way for you to give extra money to your staff. While you could make direct payments to your employees, it’s very common to combine profit sharing with an employer-sponsored retirement plan. That way, you reward your employees—and help them save for a brighter future. What is a profit sharing plan? A profit sharing plan is a type of defined contribution plan that allows you to help your employees save for retirement. With this type of plan, you make “nonelective contributions” to your employees’ retirement accounts. This means that each year, you can decide how much cash (or company stock, if applicable) to contribute—or whether you want to contribute at all. It’s important to note that the name “profit sharing” comes from a time when these plans were actually tied to the company’s profits. Nowadays, companies have the freedom to contribute what they want, and they don’t have to tie their contributions to the company’s annual profit (or loss). In a pure profit sharing plan, employees do not make their own contributions. However, most companies offer a profit sharing plan in conjunction with a 401(k) plan. What is a profit sharing 401(k) plan? A 401(k) with profit sharing enables both you and your employees to contribute to the plan. Here’s how it works:  The 401(k) plan allows employees to make their own salary deferrals up to the IRS limit.  The profit sharing component allows employers to contribute up to the IRS limit, noting that the maximum includes the employee's contributions as well.   After the end of the year, employers can make their pre-tax profit sharing contribution, as a percentage of each employee’s salary or as a fixed dollar amount Employers determine employee eligibility, set the vesting schedule for the profit sharing contributions, and decide whether employees can select their own investments (or not) What’s the difference between profit sharing and an employer match? Profit sharing and employer matching contributions seem similar, but they’re actually quite different: Employer match—Employer contributions that are tied to employee savings up to a certain percentage of their salary (for example, 50 cents of every dollar saved up to 6% of pay) Profit sharing—An employer has the flexibility to choose how much money—if any at all—to contribute to employees’ accounts each year; the amount is not tied to how much employees save. What kinds of profit sharing plans are there? There are four main types of profit sharing plans:  Pro-rata plan—Every plan participant receives employer contributions at the same rate. For example, every employee receives the equivalent of 5% of their salary or every employee receives a flat dollar amount such as $1,000. Why is it good? It’s simple and rewarding. New comparability profit sharing plan (otherwise known as “cross-tested plans”)—Employees are placed into separate benefit groups that receive different profit sharing amounts. For example, business owners (or other highly compensated employees) are in one group that receives the maximum contribution and all other employees are in another group and receive a lower amount. Why is it good? It offers older owners the most flexibility.  Minimum Gateway – In order to utilize new comparability, the plan must satisfy the Minimum Gateway Contribution – All non-highly compensated employees (NHCEs) must receive an allocation that is no less than the lesser of 5% of the participant's gross compensation, or 1/3 of the highest contribution rate given to any highly compensated employees (HCEs). General Test – Once the minimum gateway is passed, it must pass the general test which breaks up the plan into “rate groups” based on their Equivalent benefit Accrual Rate (EBAR). Every HCE is in their separate rate group, which includes all participants who have an EBAR equal to or greater than that HCE. If the ratio percentage for each rate group is 70% or higher, the plan passes, and no further testing is necessary. If each rate group does not satisfy the ratio percentage test, then we revert to using the average benefits test. The average benefits test is the more complicated test, and consists of two parts: the nondiscriminatory classification test and the average benefits test. Betterment will always try to make the test pass using the ratio test method first. Permitted disparity—Employees are given a pro-rata base contribution on their entire compensation (up until the IRS limit). In addition, employees who earn more than the integration level, will receive an excess contribution on the amount over that limit. The integration level that provides the highest disparity allowed (5.7%) is the Social Security Taxable Wage Base (SSTWB). Plans that choose to lower the integration amount will receive a reduced disparity limit. Why is it good? It offers younger HCE’s who make more than the SSTWB a greater benefit. Age-weighted profit sharing plan—Employees are given profit sharing contributions based on their retirement age. That is, the older the employee, the higher the contribution. Why is it good? It can help with employee retention. How do I figure out our company’s profit sharing contribution? First, consider which type of profit sharing plan you’ll be using—pro-rata, new comparability, permitted disparity, or age-weighted. Next, take a look at your company’s profits, business outlook, and other financial factors. Keep in mind that: There is no set amount that you have to contribute You don’t need to make contributions Even though it’s called “profit sharing,” you don’t need to show profits on your books to make contributions The IRS notes that the “comp-to-comp” or pro-rata method is one of the most common ways to determine each participant’s allocation. Using this method, you calculate the sum of all of your employees’ compensation (the “total comp”). To determine the profit sharing allocation, divide the profit sharing pool by the total comp. You then multiply this percentage by each employee’s salary. Here’s an example of how it works: Your profit sharing pool is $15,000, and the combined compensation of your three eligible employees is $180,000. Therefore, each employee would receive a contribution equal to 8.3% of their salary. Employee Salary Calculation Profit sharing contribution Taylor $40,000 $15,000 x 8.3% $3,333 Robert $60,000 $15,000 x 8.3% $5,000 Lindsay $80,000 $15,000 x 8.3% $6,667 What are the key benefits of profit sharing for employers? It’s easy to see why profit sharing helps employees, but you may be wondering how it helps your small business. Consider these key benefits: Provide a valuable benefit (while controlling costs)—With employer matching contributions, your costs can dramatically rise if you onboard several new employees. However, with profit sharing, the amount you contribute is entirely up to you. Business is doing well? Contribute more to share the wealth. Business hits a rough spot? Contribute less (or even skip a year). Attract and retain top talent—Profit sharing is a generous perk when recruiting new employees. Plus, you can tweak your profit sharing rules to aid in retention. For example, some employers may elect to have a graded or cliff profit sharing contribution vesting schedule to motivate employees to continue working for their company. Rack up the tax deductions—Profit sharing contributions are tax deductible and not subject to payroll (e.g., FICA) taxes! So if you’re looking to lower your taxable income in a profitable year, your profit sharing plan can help you make the highest possible contribution (and get the highest possible tax write-off). Motivate employees to greater success—Employees who know they’ll receive financial rewards when their company does well are more likely to perform at a higher level. Companies may even link profit sharing to performance goals to motivate employees. What are the rules? The IRS clearly defines rules for contribution limits and calculation rules, tax deduction limits, deadlines, and disclosures (as with any type of 401(k) plan!). Be sure to keep an eye out for any annual changes from the IRS. Are there any downsides to offering a profit sharing plan? Contribution rate flexibility is one of the greatest benefits of a profit sharing 401(k) plan—but it could also be one of its greatest downsides. If business is down one year and employees get a lower profit sharing contribution than they expect, it could have a detrimental impact on morale. However, for many companies, the advantages of a profit sharing 401(k) plan outweigh this risk. How do I set up a profit sharing 401(k) plan? If you already have a 401(k) plan, it requires an amendment to your plan document. However, you’ll want to take the time to think through how your profit sharing plan supports your company’s goals. Betterment can help. At Betterment, we’re here to help with a range of tasks from nondiscrimination testing to plan design consulting to ensure your profit sharing 401(k) plan is working the way your business needs. And as a 3(38) fiduciary, we take full responsibility for selecting and monitoring your investments so you can focus on running your business—not managing your retirement plan. Ready for a better profit sharing 401(k) plan? Get started here.   The information provided is education only and is not investment or tax advice. Any links provided to other websites are offered as a matter of convenience and are not intended to imply that Betterment or its authors endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.

The Importance and Benefits of Offering Employer Match Some employees resist saving because they feel retirement is too far away, can’t afford it, or can’t grasp the benefit. You can help change that mentality by offering a 401(k) employer match. Beyond being an attractive employee benefit, a 401(k) plan can act as a catalyst for employees at all career stages to save for retirement. Some employees, however, will resist saving because they feel retirement is too far away, or can’t afford it, or can’t make room in their budget (and current spending levels). However, as a 401(k) plan sponsor, you can help change that mentality by offering a 401(k) employer matching contribution. What is a 401(k) employer matching contribution? With an employer match, a portion or all of an employee’s 401(k) plan contribution will be “matched” by the employer. Common matching formulas include: Dollar-for-Dollar Match: Carla works for ABC Company, which runs payroll on a semi-monthly basis (two times a month = 24 pay periods a year). Her gross pay every period is $2,000. She has decided to defer 4% of her pre-tax pay every pay period, or $80 (4% x $2,000). The ABC Company 401(k) plan generously offers a dollar-for-dollar match up to 4% of compensation deferred. With each payroll, $80 of Carla’s pay goes to her 401(k) account on a pre-tax basis, and ABC Company also makes an $80 matching contribution to Carla’s 401(k) account. At a 4% contribution rate, Carla is maximizing the employer contribution amount. If she reduces her contribution to 3%, her company matching contribution would also drop to 3%; but if she increases her contribution to 6%, the formula dictates that her employer would only contribute 4%. Partial Match (simple): Let’s take the same scenario as above, but ABC Company 401(k) plan matches 50% on the first 6% of compensation deferred. This means that it will match half of the 401(k) contributions. If Carla contributes $80 to the 401(k) plan, ABC Company will contribute $40 on top of her contribution as the match. Tiered Match: By applying different percentages to multiple tiers, employers can encourage employees to contribute to the plan while controlling their costs. For example, ABC Company could match 100% of deferrals up to 3% of compensation and 50% on the next 3% of deferrals. Carla contributes 4% of her pay of $2,000, which is $80 per pay period. Based on their formula, ABC Company will match her dollar-for-dollar on 3% of her contribution ($60 = 3% x $2,000), and 50 cents on the dollar on the last 1% of her contribution for a total matching contribution of $70 or 3.5%. The plan’s matching formula is chosen by the company and specified in the plan document or may be defined as discretionary, in which case the employer may determine not only whether or not to make a matching contribution in any given year, but also what formula to use. Is there a limit to how much an employer can match? The IRS limits annual 401(k) contributions, and these limits change from year to year. It’s also important to note that the IRS caps annual compensation that’s eligible to be matched. Potential Benefits of Providing an Employer Match Attract talent: Offering a 401(k) is a great way to set your company apart from the competition, and a matching contribution sweetens the deal! A Betterment at Work study found that 68 percent of respondents would prioritize having better financial wellness benefits above an extra week of vacation! Better 401(k) plan participation: Unlike other types of employer contributions, a matching contribution requires employees to contribute their own money to the plan. In other words, the existence of the match drives plan participation up (not contributing is like leaving money on the table), encouraging employee engagement and increasing the likelihood of having your plan pass certain compliance tests. Financial well-being of employees: A matching contribution shows employees that you care about their financial well-being and are willing to make an investment in their future. The additional funds can help employees reach their retirement savings goal. Improved retention: The match is essentially “free money” that can be considered part of an employee’s compensation, which can be hard to give up. And by applying a vesting schedule to the employer match, you can incentivize employees to stay longer with your company to gain the full benefits of the 401(k) plan. Employer tax deduction: matching contributions are tax deductible, which means you can   deduct them from your company’s income so long as they don’t exceed IRS limits.  Offering a 401(k) plan is already a huge step forward in helping your employees save for their retirement. Providing a 401(k) matching contribution enhances that benefit for both your employees and your organization. Ready for a better 401(k) solution? Whether you’re considering a matching contribution or not, Betterment is here to help. We offer an all-in-one dashboard that seeks to simplify plan administration, at one of the lowest costs in the industry.,  Our dedicated onboarding team, and support staff are here to help you along the way. Any links provided to other websites are offered as a matter of convenience and are not intended to imply that Betterment or its authors endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.