401(k) QNECs & QMACs: what are they and does my plan need them?
QNECs and QMACs are special 401(k) contributions employers can make to correct certain ...401(k) QNECs & QMACs: what are they and does my plan need them? QNECs and QMACs are special 401(k) contributions employers can make to correct certain compliance errors without incurring IRS penalties. Even the best laid plans can go awry, especially when some elements are out of your control. Managing a 401(k) plan is no different. For example, your plan could fail certain required nondiscrimination tests depending solely on how much each of your employees chooses to defer into the plan for that year (unless you have a safe harbor 401(k) plan that is deemed to pass this testing.) QNECs and QMACs are designed to help employers fix specific 401(k) plan problems by making additional contributions to the plan accounts of employees who have been negatively affected. What is a QNEC? A Qualified Nonelective Contribution (QNEC) is a contribution employers can make to the 401(k) plan on behalf of some or all employees to correct certain types of operational mistakes and failed nondiscrimination tests. They are typically calculated based on a percentage of an employee’s compensation. QNECs must be immediately 100% vested when allocated to participants’ accounts. This means they are not forfeitable and cannot be subject to a vesting schedule. QNECs also must be subject to the same distribution restrictions that apply to elective deferrals in a 401(k) plan. In other words, QNECs cannot be distributed until the participant has met one of the following triggering events: severed employment, attained age 59½, died, become disabled, or met the requirements for a qualified reservist distribution or a financial hardship (plan permitting). These assets may also be distributed upon termination of the plan. What is a QMAC? A Qualified Matching Contribution (QMAC) is also an employer contribution that may be used to assist employers in correcting problems in their 401(k) plan. The QMAC made for a participant is a matching contribution, based on how much the participant is contributing to the plan (as pre-tax deferrals, designated Roth contributions, or after-tax employee contributions), or it may be based on the amount needed to bring the plan into compliance, depending on the problem being corrected. QMACs also must be nonforfeitable and subject to the distribution limitations listed above when they are allocated to participant’s accounts. QNECs vs. QMACs Based on % of employee’s compensation based on amount of employee’s contribution QNECs (Qualified Nonelective Contribution) QMACs (Qualified Matching Contribution) Commonly used to pass either the Actual Deferral Percentage (ADP) or Actual Contribution Percentage (ACP) test Most commonly used to pass the Actual Contribution Percentage (ACP) test Frequently Asked Questions about QNECs and QMACs How are QNECs and QMACs used to correct nondiscrimination testing failures? One of the most common situations in which an employer might choose to make a QNEC or QMAC is when their 401(k) plan has failed the Actual Deferral Percentage (ADP) test or the Actual Contribution Percentage (ACP) test for a plan year. These tests ensure the plan does not disproportionately benefit highly compensated employees (HCEs). The ADP test limits the percentage of compensation the HCE group can defer into the 401(k) plan based on the deferral rate of the non-HCE group. The ACP test ensures that the employer matching contributions and after-tax employee contributions for HCEs are not disproportionately higher than those for non-HCEs. When the plan fails one of these tests at year-end, the employer may have a few correction options available, depending on their plan document. Many plans choose to distribute excess deferrals to HCEs to bring the HCE group’s deferral rate down to a level that will pass the test. Your HCEs, however, may not appreciate a taxable refund at the end of the year or a cap on how much they can save for retirement. Making QNECs and QMACs are another option for correcting failed nondiscrimination tests. This option allows HCEs to keep their savings in the plan because the employer is making additional contributions to raise the deferral or contribution rate of the lower paid employees (non-HCEs) to a level that passes the test. How much would I have to contribute to correct a testing failure? For QNECs, the plan usually allows the employer to contribute the minimum QNEC amount needed to boost the non-HCE group’s deferral rate enough to pass the ADP test. The contribution formula may require that an allocation be a specific percentage of compensation that will be given equally to all non-HCEs, or it may allow the allocation to be used in a more targeted fashion that gives the amount needed to pass the test to just certain non-HCEs. QMACs are most commonly made to pass the ACP test. As with QNECs, there are allocation options available to the plan sponsor when making QMACs. A plan sponsor can make targeted QMACs, which are an amount needed to satisfy a nondiscrimination testing failure, or they can allocate QMACs based on the percentage of compensation deferred by a participant. QNECs and QMACs can both be made to help pass the ADP and ACP tests, but a contribution cannot be double counted. For example, if a QNEC was used to help the plan pass the ADP test, that QNEC cannot also be used to help pass the ACP test. How long do I have to make a QNEC or QMAC to correct a testing failure? QNECs/QMACs used to correct ADP/ACP tests generally must be made within 12 months after the end of the plan year being tested. Beware, however, if you use the prior-year testing method for your ADP/ACP tests. If you use this testing method, the QNEC/QMAC must be made by the end of the plan year being tested. For example, if you’re using the prior-year testing method for the 2020 plan year ADP test, the non-HCE group’s deferral rate for 2019 is used to determine the passing rate for HCE deferrals for 2020 testing. Using this prior-year method can help plans proactively determine the maximum amount HCEs may defer each year. But, if the plan still fails testing for some reason, a QNEC or QMAC would have to be made by the end of 2020, which is before the ADP/ACP test would be completed for 2020. QNECs and QMACs deposited by the employer’s tax-filing deadline (plus extensions) for a tax year will be deductible for that tax year. What other types of compliance issues may be corrected with a QNEC or QMAC? Through administrative mix-ups or miscommunications with payroll, a plan administrator might fail to recognize that an employee has met the eligibility requirements to enter the plan or fail to notify the employee of their eligibility. These types of errors tend to happen especially in plans that have an automatic enrollment feature. And sometimes, even when the employee has made an election to begin deferring into the plan, the election can be missed. These types of errors are considered a “missed deferral opportunity.” The employer may correct its mistake by contributing to the plan on behalf of the employee. How is a QNEC or QMAC calculated for a “missed deferral opportunity”? When a missed deferral opportunity is discovered, the employer can correct this operational error by making a QNEC contribution up to 50% of what the employee would have deferred based on their compensation for the year and the average deferral rate for the group the employee belongs to (HCE or non-HCE) for the year the mistake occurred. The QNEC must also include the amount of investment earnings that would be attributable to the deferral had it been contributed timely. If a missed deferral opportunity is being corrected and the plan is a 401(k) safe harbor plan, the employer must make a matching contribution in the form of a QMAC to go with the QNEC to make up for the missed deferrals, plus earnings. Is there a way to reduce the cost of QNECs/QMACs? Employers who catch and fix their mistakes early can reduce the cost of correcting a compliance error. For example, no QNEC is required if the correct deferral amount begins for an affected employee by the first payroll after the earlier of 3 months after the failure occurred, or The end of the month following the month in which the employee notified the employer of the failure. Plans that have an automatic enrollment feature have an even longer time to correct errors. No QNEC is required if the correct deferral amount begins for an affected employee by the first payroll after the earlier of 9½ months after the end of the plan year in which the failure occurred, or The end of the month after the month in which the employee notified the employer of the failure. If it has been more than three months but not past the end of the second plan year following the year in which deferrals were missed, a 25% QNEC (reduced from 50%) is sufficient to correct the plan error. The QNEC must include earnings and any missed matching contributions and the correct deferrals must begin by the first payroll after the earlier of: The end of the second plan year following the year the failure occurred, or The end of the month after the month in which the employee notified the employer of the failure. For all these reduced QNEC scenarios, employees must be given a special notice about the correction within 45 days of the start of the correct deferrals. For More Information These rules are complex, and the calculation of the corrective contribution, as well as the deadline to contribute, varies based on the type of mistake being corrected. You can find more information about correcting plan mistakes using QNECs or QMACs on the IRS’s Employee Plans Compliance Resolution System (EPCRS) webpage. And you can contact your Betterment for Business representative to discuss the correction options for your plan. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
What is a Fidelity Bond?
401(k) plan sponsors are required to purchase a fidelity bond to protect the plan against ...What is a Fidelity Bond? 401(k) plan sponsors are required to purchase a fidelity bond to protect the plan against fraudulent or dishonest acts. Here are answers to common questions. What is a fidelity bond? A fidelity bond is a type of insurance required for those responsible for the day-to-day administration and handling of “funds or other property” of an ERISA (Employee Retirement Income Security Act of 1974) benefit plan such as a 401(k). The purpose of the bond is to protect the plan from losses due to acts of fraud or dishonesty including theft, embezzlement, larceny, forgery, misappropriation, wrongful abstraction, wrongful conversion and willful misapplication. What are “Funds Or Other Property”? “Funds or other property” refers to 401(k) plan assets. In addition to publicly-traded stocks, bonds, mutual funds, and exchange-traded funds, all employee and employer contributions are considered “funds,” whether they come in the form of cash, check or property. Who must be covered by a fidelity bond? Under ERISA, it is illegal to receive, disburse, or exercise custody or control of plan funds or property without having a fidelity bond in place. Therefore, anyone who handles or manages 401(k) funds must be covered by a fidelity bond. This includes anyone who has: Physical contact with cash, checks, or similar property Authority to secure physical possession of cash, checks, or similar property through access to a safe deposit box, bank accounts, etc. Authority to transfer plan funds either to oneself or a third party Authority to disburse funds Authority to sign or endorse checks Supervisory or decision-making authority over plan funds This requirement is not just limited to plan managers and plan sponsor employees. Third party service providers that have access to the plan’s funds or exercise decision-making authority over the funds may also require bonding. This includes investment advisors and third-party administrators (TPAs). How much coverage is required? ERISA requires each person handling the plan to be covered for at least 10% of the amount of funds they handle. The coverage can’t be less than $1,000 or more than $500,000, (unless the plan includes employer securities, in which case the maximum amount can be $1,000,000). The exception to the 10% rule applies to ‘non-qualifying plan assets” that may represent more than 5% of the plan’s total assets. Qualifying assets include items held by a financial institution such as a bank, insurance company, mutual funds, etc. Non-qualifying assets are those not held by any financial institution including tangibles such as artwork, collectibles, non-participant loans, property, real estate and limited partnerships. Fidelity bonds have a minimum term of one year. Longer-term bonds will typically include an inflation provision so the value of the bond will increase automatically. The bond amount should be reviewed and updated as the plan assets increase or decrease. Where can I obtain a fidelity bond? The bond must be issued by an underwriter from an insurance company that is listed on the Department of Treasury’s Listings of Approved Sureties. These are companies that have been certified by the Treasury Department. Fidelity bond application During the application process, some plan information may be required. Common items the application will ask is the plan name, address, IRS plan number (ex. 001), and trustee information. Most of the items asked can be found under the administrative information section (usually second to last page) within the Summary Plan Description (SPD). What happens if I don’t cover my plan with a Fidelity Bond? The existence and amount of the plan’s fidelity bond must be reported on your plan’s annual Form 5500 filing. Not having a bond, or not having sufficient coverage based on plan assets, may trigger a DOL audit and may risk the plan’s tax-qualified status. Additionally, the plan fiduciaries may be held personally liable for any losses that may occur from fraudulent or dishonest acts.
How a Competitive Compensation Package Can Attract Top Talent
As an employer, you know that there’s a lot more to keeping employees happy. Let’s review the ...How a Competitive Compensation Package Can Attract Top Talent As an employer, you know that there’s a lot more to keeping employees happy. Let’s review the five most important aspects of competitive compensation packages. Offering an endless supply of snacks. Giving employees their birthday as a paid holiday. Turning the conference room into a massage room. Every day, there’s a new perk popping up at companies across the United States. As an employer, you know that there’s a lot more to keeping employees happy than beer on tap and dogs at work. But what really matters to employees? How can the right benefits help you attract and retain top talent? And what does a competitive compensation strategy really look like? Let’s start by reviewing the five most important aspects of competitive compensation packages. 1. Money talks, salary matters The million-dollar question every prospective employee wants to ask is: “How much will I get paid?” There’s no question about it—the value of your compensation packages will often determine the caliber of employee you’re able to attract and retain. According to the Society for Human Resource Management (SHRM), salary ranges help employers control their payroll expenses and ensure pay equity among their staff members. Before you decide if you’re going to set salaries at, above, or below the market range, think about your company’s compensation philosophy. For example, if you’re trying to become a market leader, you may want to pay employees more than your competitors. Wondering what your competitive salary ranges are? Some research is in order. Based on geographic location, analyze the salary ranges for all of your company’s jobs. Beyond base pay, you’ll also want to consider bonuses, commissions, and equity. Need a little help? Websites like glassdoor.com can offer a peek inside salaries at other companies, or you could consider hiring a vendor to analyze and assist with pay scales. Want to compete? Pay at or above the market range (or have other generous benefits that make up the difference). 2. A healthy attitude about health insurance An important part of employees’ total compensation is health insurance. While some employers offer coverage to employees only, most employers extend the option of coverage to employees’ immediate family members. In addition, some employers also offer dental insurance, vision insurance, short-term and long-term disability, life insurance, and pet insurance. According to research by the Kaiser Family Foundation, the average cost of employer-sponsored health insurance in terms of annual premiums was $7,188 for single coverage and $20,576 for family coverage. Typically, the employee and the employer each pay a portion of the premium. However, very generous employers may cover 100% of the premium cost of a basic plan and give employees the option to select a higher-level plan (and just pay the cost difference). Want to compete? At a minimum, provide employees with health care, vision, and dental insurance and cover some or all of the premium. 3. Time to rest, recharge, and recover After asking about salary, most employees want to know about paid time off (PTO). Typically, companies handle PTO in one of three ways: Single PTO balance—A total number of days (for example, 14 days) that employees can use at their discretion when they’re sick, want to take a vacation, or just want time for themselves. If employees don’t take all their time off, some companies allow them to roll over days to the next year and even cash them out when they leave the company. Separate PTO balances for sick, vacation, and personal—Separate buckets of PTO (for example, 5 sick days, 10 vacation days, and 2 personal days) that employees can use for that specific purpose. Like with the single PTO balance, you’ll need to figure out your roll-over and cash-out policy. Unlimited PTO—The newest trend in PTO, many companies are allowing employees to take as many days off as they want (and for whatever reason) as long as they’re meeting their performance goals. In addition, many employers provide the typical paid holidays such as Thanksgiving, Memorial Day, and Labor Day. When it comes to managing PTO benefits, you’ll also need to comply with federal, state, and local laws (including regulations on family and medical leave (FMLA), hourly wage minimums, and military leave). However, just offering the basics may not be enough to entice prospective employees. For example, FMLA allows eligible employees to take unpaid, job-protected maternity leave for 12 weeks. To better serve their employees, many companies go above and beyond this standard by offering paid maternity leave (and increasingly, paid paternity leave) for several weeks or even months. Want to compete? Do a market analysis to ensure you offer a competitive leave policy—and then sweeten the pot with an extra perk such as a floating holiday. 4. Future focused, retirement ready After their day-to-day needs are met, employees start looking to the future. As an employer, you can help them achieve the retirement they envision by offering a retirement plan. The most popular type of workplace retirement program today is the 401(k) plan. On the fence about offering a 401(k) plan as part of your benefits package? Consider these top three reasons to start one today: Attract (and retain) employees—In the battle for top talent, a competitive 401(k) plan with perks like matching contributions can entice jobseekers to join your company. (Plus, a company match may cost less than you think.) Help your employees build a brighter future—Studies show that financial stress can have a damaging impact on business output, lead to higher employee turnover, and increase recruiting costs. Help mitigate that stress by offering a 401(k) plan that allows your employees to save for their future with confidence. Enjoy valuable tax advantages—Employer matching, profit sharing, and safe harbor contributions are tax deductible and bypass payroll taxes! Plus, small businesses can receive valuable tax credits to help offset the costs of your 401(k) plan. Want to compete? Offer a 401(k) plan with a company matching contribution. 67% of employees surveyed by Betterment said that a good 401(k) was an important factor when evaluating a job offer. 5. Take stock of employee stock options For start-ups and other emerging companies, employee stock options are also a popular form of compensation. Employees may even join the company for a lower-than-usual salary in exchange for a generous package of stock options. So what exactly is a stock option? Well, it’s a contract that gives employees the right to buy (or “exercise”) a set number of shares of the company’s stock at a pre-set price. However, employees must buy the shares within a certain time period—and after it expires, they no longer have the option to do so. If the company prospers, employees who have exercised their stock options could become very wealthy. By giving employees stock options, you also give them a good reason to be invested (literally) in their company’s success. Perks, perks and more perks So what about the free beer and nap rooms dreamed up by HR professionals? According to Forbes Magazine’s Forbes Coaches Council some of those benefit offerings are nothing more than a gimmick. In fact, they may be perceived negatively by employees. For example, free food, booze, and places to crash could be seen as a contrived way to hurt employees’ work-life balance by incentivizing them to work longer hours. However, there may be some extra perks—like remote working arrangements or student loan repayments—that could resonate well with your employees. Wondering which extra compensation and benefits perks could work? Start the conversation with your staff. From one-on-one meetings to employee surveys, there are many ways to take the pulse of your workforce. So, what will it all cost? As you can imagine, total compensation varies dramatically across geographic location, industry, and role. You can dig deeper into employee benefit benchmarking data by partnering with a compensation company to develop a better understanding of your local and regional competition. With this data, you can examine compensation at a more granular level to understand if your company is on target—or may need a compensation adjustment. After all, more competitive compensation means more qualified employees—and potentially more business success. Betterment can help In the competition for top talent, every single benefit matters. For jobseekers, a strong 401(k) plan can make all the difference. So if you want to enhance your total compensation package, consider offering a 401(k) plan or adding a company match to your existing plan. While some employee benefits are very costly, the good news is that offering your employees a quality 401(k) plan may cost less than you think. At Betterment, our fees are a fraction of the cost of most providers. As your full-service partner, we can help design your ideal 401(k) plan with employee-friendly benefits like company matching contributions and automatic enrollment.
All Plan Compliance articles
Did Your 401(k) Plan Fail Its Compliance Test?Did Your 401(k) Plan Fail Its Compliance Test? After another busy 401(k) compliance season, we sat down with Mikang Kim, Senior 401(k) Compliance Manager at Betterment, to get her perspective on plan failures: why they happen, what a plan sponsor can do about them, and how to decrease the likelihood of failing going forward. Compliance Failure Q&A Q: First things first: what exactly is 401(k) compliance testing and when is it performed? Sometimes called “non-discrimination” testing, compliance testing is conducted shortly after the close of a plan year, so roughly mid-January through mid-April for calendar year plans. In short, a 401(k) plan must pass these tests each year to verify that it does not benefit highly compensated employees (HCEs) at the expense of non-highly compensated employees (NHCEs) unfairly. Although there are a number of compliance tests, one of the most important is the “actual deferral percentage,” or ADP, test. Q: What exactly does the ADP test look at? With the ADP test, we compare the average 401(k) deferral percentage for HCEs to the average 401(k) deferral percentage of NHCEs. If the difference is greater than a certain margin (as shown in the table below), the plan is said to have “failed” the ADP test. Average NHCE rate Maximum HCE Average Rate Under 2% 2 x NHCE Rate 2% to 8% 2% + NHCE Rate Over 8% 1.25 x NHCE Rate It’s important to note that the average deferral rate for testing purposes takes into account all eligible employees, including both active and terminated employees for the plan year. As a side note, this might differ from how the average deferral rate is defined for plan health purposes, which usually looks at the average deferral rate only of those participants who are actively contributing. Q: What exactly are the consequences of failing the ADP test? It’s probably scarier than it sounds because it can be fairly easily corrected. There are two ways to correct the failure. One is to refund excess 401(k) contributions to the impacted HCEs. The refund amount is dependent on the size of the failure, but it is taxable to the affected employees (often owners and senior managers) who will likely be unpleasantly surprised by this turn of events. It’s never an easy conversation for the plan administrator to have. The second method is to make a corrective contribution (equal to the failed margin) known as a Qualified Non-elective Contribution (QNEC) to all of the non-highly compensated employees. This may be costly to the employer, but if the failed margin is small and the company is on the smaller side, this may be a good alternative to correct the failure. Generally, this correction needs to be completed by two and a half months after the end of the plan year being tested (March 15 for calendar year plans). Q: OK, before we go any further, let’s make sure everyone is on the same page with respect to the definitions of HCE and NHCE. Ah, and that’s where some of the 401(k) fun comes in because there are actually different ways that these categories of employees can be defined. And the plan sponsor has some flexibility in choosing the definition that may make it easier for the plan to pass compliance testing. But one thing that’s important to know is that you only have to define who falls within the HCE category since NHCEs are just the residual (i.e., everyone else). Compensation is understandably one factor in determining whether someone is an HCE or not. But it’s based on prior year compensation data. So if we’re in February of 2021, doing 2020 compliance testing on a plan, we’d need 2019 compensation data from the plan sponsor. That can cause a lot of confusion at first, especially for plans that just started up. For example, a plan that started in June 2020 will understandably question why they need to provide us with company compensation data —before the 401(k) plan was even in existence. It’s because we need to determine who was an HCE, and that’s based on the prior year, also known as a “lookback year.” Obviously, if the company wasn’t even in existence in the prior year, we would then have to rely on more recent data. And in fact, in such a case, we wouldn’t rely on compensation to define HCEs, but just the ownership definition, which we’ll get into. Q: So it sounds like the next logical question then is: what are the different HCE definitions? Sure. Certain types of employees are automatically defined as HCEs regardless of their compensation. This can be tricky for businesses, especially those that are small and/or family run. An HCE is an employee who meets one of the following criteria: Ownership in Current or Prior Year – regardless of compensation, owns over 5% of (1) outstanding corporate stock, (2) voting power across corporate stock, or (3) capital or profits of an entity not considered a corporation. This includes family members. Prior year compensation exceeds IRS definition of HCE. This is regardless of current year compensation. In 2019, this amount was $125,000. Q: I guess this leads to other methods of defining HCEs and NHCEs. Exactly. Alternatively, larger plans especially may wish to define HCEs using the Top-Paid Group Election (TPG) method that allows them to limit the number of HCEs to their top 20% of employees based on prior year compensation. This must be defined in the plan document and could be beneficial if high earners who aren’t in that top 20% are contributing significantly, which in turn can help boost the average contribution rate of the other 80%. One thing to note is that any employees who are considered highly compensated under the ownership definition will still be treated as HCEs, regardless of compensation. So the exact percentage of HCEs using the TPG method may actually exceed 20%. Q: So what are some factors that contribute to ADP testing failures? One of the most common challenges we see happens when plans start late in the year. Often, HCEs who have more discretionary income are so excited about the plan and the ability to maximize their savings and their tax deferrals. So even with just a few payroll periods left in the year, they maximize their contributions, contribute at much higher rates than NHCEs, and cause the plan to fail. Plans that start late in the year should be aware of this potential problem. If they don’t want to delay starting the plan, they should communicate to HCEs that they will be unlikely to contribute the maximum annual amount (and may risk receiving a taxable refund of contributions after the year ends). Our message to plan administrators, though, is this: if the sole focus for starting a 401k plan is to allow the owner or other HCEs to max out their contributions, be forewarned that your plan may fail the ADP test. Remember that as a fiduciary, you must operate the plan in the interests of all of your employees. Q: Any other things to watch out for? Other plans that may need to be more cautious include small plans, especially where the owner may be the only HCE. If other employees aren’t contributing or contributing enough, that can be difficult. Another wrinkle can occur when there are HCEs who are earning less than the statutory maximum compensation amount. Among other things, this is the maximum amount that can be used when performing the test calculations. Consider an HCE under age 50 who is contributing the maximum annual 401(k) contribution of $19,500. If they are earning the statutory maximum compensation amount of $285,000 for 2020, that is the equivalent of 6.8% of salary. However, if they are earning just $150,000 (which also qualifies them as an HCE), that same $19,500 translates into a 13% contribution rate. So the range of HCE compensation can have a huge impact on that HCE ADP. Q: How can plans ensure that they don’t fail the ADP test? For those who aren’t aware, there’s one very easy solution. The ADP compliance test can be bypassed altogether if the plan adopts a Safe Harbor plan design, which requires a mandatory contribution. Of course, the company needs to weigh the added expense against the benefits of reduced compliance headaches and potentially better funded retirements for their employees. But for plans who are starting late in the year, adopting Safe Harbor is a great way to avoid potential testing failures and having to refund contributions to HCEs. Q: And what if the Safe Harbor plan design is just too costly? Short of adopting a Safe Harbor plan design, there are other things plans can do to reduce the likelihood of failing the test. For instance, implementing automatic enrollment for all employees at a rate that is sufficiently high can go a long way. Most people do not opt-out of the plan or change their default contribution amount. So if the plan contributes everyone at, say 6%, there’s probably a much better chance that the plan will pass ADP testing. In addition, sometimes (but not always) a matching contribution can really motivate employees to save more. For instance, if employees have to contribute 6% to earn the maximum employer contribution, they will be more likely to contribute that amount. Often this requires clear and consistent communication to be sure that employees newly eligible for the plan are also aware of the matching feature and how they can earn the maximum amount. That said, if an employer is willing to take on the expense of a matching contribution, then a Safe Harbor plan design may make more sense since that eliminates the uncertainty associated with compliance testing altogether. Plans may also decide to use the Prior Year testing method, which allows them to limit HCE plan contributions going forward based on the results of the prior year tests. This is not a guarantee that the plan will pass the ADP test, but it reduces the likelihood. Q: What’s your advice to plans that have failed the ADP test? First of all, don’t panic. It’s not uncommon for plans to fail the ADP test. That said, it’s worth analyzing what else is going on with plan design that could be negatively impacting participation or contribution rates. For instance: Is the eligibility requirement restricting from contributing to the plan who otherwise might thereby helping boost NHCE engagement? Is the plan being made available to all employees who are eligible according to the plan document? Unless it’s written in the plan document that part-time and/or seasonal employees such as interns cannot contribute to the plan until they meet certain eligibility requirements (specific to this employee class), they must be given the opportunity to contribute to the plan. Are definitions of plan compensation (excluding pre-participation compensation for instance) skewing the average contribution percentages and impacting testing in unexpected ways? Of course, we caution everyone that testing can change from year to year, especially for new plans or companies just starting out, so it’s not something that’s one and done. New plans who pass their first year should especially guard against getting too complacent in thinking they won’t have any problems in the future. In addition, plans should monitor plan engagement, paying attention not just to the participation rate but the average contribution rate of different employee groups, and continue to communicate the benefits of the plan, particularly to those groups who need to hear it most. Betterment can work with plans to develop a strategy for reaching out to their employees. Q&A was conducted in 2021 and is meant to be educational in nature.
What is a 401(k) Plan Audit?What is a 401(k) Plan Audit? If an audit of your 401(k) plan is required, Betterment can help you understand what to expect and how to prepare. The Employee Retirement Income Security Act of 1974 (ERISA) requires that certain 401(k) plans be audited annually by a qualified independent public accountant subject. The primary purpose of the audit is to ensure that the 401(k) plan is operating in accordance with Department of Labor (DOL) and Internal Revenue Service (IRS) rules and regulations as well as operating consistent with the plan document, and that the plan sponsor is fulfilling their fiduciary duty. A 401(k) plan audit can be fairly broad in scope and usually includes a review of all of the transactions that took place throughout the plan year such as payroll uploads, distributions, corrective actions, and any earnings that were allocated to accounts. It will also include a review of administrative procedures and identify potential areas of concern or opportunities for improvement. When does a 401(k) Plan need an audit? Whether or not your plan requires an audit is determined by the number of participants in your plan at the beginning of the plan year. In this case, participants include not just those employees actively contributing to the plan but also those who were eligible but not participating as well as any terminated participants with a balance. Generally speaking, ERISA requires an audit for any plan that had 100 or more participants (so-called “large plans”) at the beginning of the plan year. However, as shown in the table below, there are exceptions to this general rule, captured in the “80-120 Participant Rule,” to address plans that may have fluctuating participant counts close to that 100 cut-off. Participant Count at Beginning of Plan Year Filing Status on Previous Year’s Form 5500 80-120 Participant Rule 100-120 participants Small Plan Considered a Small Plan (no audit required) until plan has more than 120 participants 80-100 participants Large Plan Considered a Large Plan (audit required) until plan has fewer than 80 participants It is therefore important to review the plan’s eligible participant count before engaging an auditor, especially if the participant count fluctuates between 80 and 120. If your plan falls under the large plan filer category, engaging a qualified independent auditor as soon as possible after plan year end is advisable. How do I prepare for a 401(k) plan audit? To get started, an auditor will request all plan-related documents, which will likely include: Executed plan document or an executed adoption agreement Any amendments to the plan document Current IRS determination letter (these are attached in the plan document we provide for plan sponsors to execute) Current and historical summary plan description and summaries of material modifications Copy of the plan’s fidelity bond insurance Copy of the most recent compliance test performed Service agreements In general, these documents should be easily accessible and current. That’s why it’s important for plan sponsors to safely keep all applicable plan-related documents, especially if there are changes made. In addition, the auditor will need financial reports of your plan. As part of its 3(16) fiduciary support services, Betterment provides a full audit package which includes: Participant contribution report Plan activity report Payroll records Schedule of plan assets Distributions and/or loans report Fees report Reports regarding investment allocation of plan assets Copies of prior Form 5500 (available on eFAST within the DOL website) Trustee certification/agreement It’s also possible that the auditor may request copies of the committee or board minutes that document considerations and decisions about the plan, including choosing service providers and monitoring plan expenses. What will happen during a 401(k) plan audit? Once the auditor receives all the necessary documents, they will review the plan to gain a solid understanding of the plan’s operations, internal controls and plan activity. The auditor will pick a sample of employees for distributions, loans or rollovers (activity of assets moving out or in of plan) and will request documentation that support such activity. For example, this may include loan applications, distribution paperwork and the image of the check or proof of funds being delivered to the participant. Once the assessments of the samples and financials are complete, the auditor will draft something called an “accountant’s opinion.” The plan sponsor should carefully review this document, which outlines any control deficiencies found during the audit. The auditor will also provide a final financial statement that must be attached to the plan’s Form 5500 before filing with the DOL. Important Deadlines for 401(k) Plan Audits Annual audits should be completed before the Form 5500 filing deadline. Form 5500s are required to be filed by the last day of the seventh month after the plan year ends. For example, if your plan year ends on December 31, your Form 5500 is due on July 31 of the following year. However, you may file an extension with the DOL using Form 5558 to get an additional 2 ½ months to file, pushing the due date to October 15 for calendar year plans. It’s important to meet the required deadline to avoid any DOL penalties.
401(k) Plan Fiduciary: How You Can Mitigate Your Risk401(k) Plan Fiduciary: How You Can Mitigate Your Risk Fiduciary responsibilities can seem daunting and time-consuming. Learn the ins and outs of your responsibilities and which ones you can delegate. You probably know that to compete in attracting new talent and retaining your best employees, a 401(k) plan has become a “must-have” benefit. Sponsoring a 401(k) plan, however, comes with both administrative and investment responsibilities. If not managed properly, these duties can be a distraction that not only takes precious time away from building your business, but can also create legal risks for you and your company. If you are just starting a 401(k) plan, make certain you understand which services will be performed by whomever you hire to administer your plan and which retirement plan tasks fall to you. A Brief History of the 401(k) Plan and Fiduciary Duties When Congress passed the Revenue Act of 1978, it included the little-known provision that eventually (and somewhat accidentally) led to the 401(k) plan. The Employee Retirement Income Security Act of 1974, referred to as ERISA, is a companion federal law that contains rules designed to protect employee savings by requiring individuals and entities that manage a retirement plan, referred to as “fiduciaries,” to follow strict standards of conduct. Fiduciaries must always act in the best interests of employees who save in the plan. When you adopt a 401(k) plan for your employees, you become an ERISA fiduciary. And in exchange for helping employees build retirement savings, you and your employees receive special tax benefits, as outlined in the Internal Revenue Code. The IRS oversees the tax rules, and the Department of Labor is the government agency responsible for providing guidance regarding ERISA fiduciary requirements and for enforcing these rules. Just like the laws and regulations that you must follow in operating your business, the tax laws and ERISA can feel like navigating a maze, with lots of twists and turns. But engaging skilled 401(k) service providers will help reduce the confusion and the burden of your retirement plan duties. Even 401(k)s of Small Businesses Come with Fiduciary Responsibilities By sponsoring a retirement plan, you take on two sets of fiduciary responsibilities. First, you are considered the “named fiduciary” with overall responsibility for the plan, including selecting and monitoring plan investments. You are also considered the “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 them manage their fiduciary responsibilities. 5 Cornerstone Rules You Must Follow As a fiduciary, you must follow the high standards of conduct required by ERISA both when managing your plan’s investments and when you are making decisions regarding plan operations. There are five cornerstone rules you must follow as an ERISA fiduciary. Each decision you make regarding your plan must be based solely on what is best for your employees who participate in the plan, and their beneficiaries. You must act prudently. Prudence requires that you be knowledgeable about retirement plan investments and administration. If you do not have the expertise to handle all of your responsibilities, you will need to engage professionals who have that expertise such as investment managers or recordkeepers. You must diversify investments to the extent needed to reduce the risk of large losses to plan assets. You must follow the terms of the plan document when operating your plan. Fees from plan assets must be reasonable and for services that are necessary for your plan. There are detailed DOL rules that outline the steps you must take to fulfill this fiduciary responsibility including collecting fee disclosures for investments and service providers and comparing (or benchmarking) the fees to make certain they are reasonable. Fiduciary Responsibilities are Serious Business Fiduciary responsibilities should not be taken lightly. Employees who participate in the plan, as well as other plan fiduciaries, have the right to bring a lawsuit to correct fiduciary wrongdoing. The DOL also has the authority to enforce the rules through civil and criminal actions. Not only can the cost of governmental penalties associated with enforcement be high, but the costs associated with fixing the problem can also be significant. These normally involve legal, accounting, and other fees. Under ERISA, fiduciaries are personally liable for plan losses caused by a breach of their fiduciary responsibilities and may be required to: restore plan losses (including interest), and pay the expenses relating to the correction of inappropriate actions. While the list of fiduciary responsibilities from above can seem daunting, the good news is that ERISA also allows you to delegate many of your fiduciary responsibilities to 401(k) professionals. Hiring 401(k) experts to manage your plan investments and operations can be a fiduciary decision. This means you should make the decision carefully. Even though you can appoint others to carry out most of your fiduciary responsibilities, you can never fully transfer or eliminate your role as an ERISA fiduciary. You will always retain the fiduciary responsibility for selecting and monitoring the investment professionals and administrators for your plan. How much responsibility you retain and how much will be handled by the outside expert will vary depending upon the level of fiduciary responsibility provided by the entities you select. This is especially true when selecting investment professionals to support the 401(k) plan. For purposes of this article, we will focus primarily on investment support services since that is often the most challenging aspect of 401(k) plan oversight for employers. This also typically poses the greatest regulatory and legal risk. Different Levels of Investment Support In most 401(k) products, you, as the plan fiduciary, are responsible for selecting and monitoring the investments that will be available to your employees through the plan. A growing number of employers have become the target of lawsuits alleging violations of fiduciary duty by selecting poor- performing or more expensive investments compared to comparable investments. For most employers, day-to-day business responsibilities leave little time for extensive investment research and analysis, including fee benchmarking. Many companies hire outside experts to take on the fiduciary investment duties. As outlined in the table below, the degree of investment fiduciary responsibility assumed by the outside experts can vary greatly, which has implications for you as an employer. Defined in ERISA Section Outside Expert Employer n/a Disclaims any fiduciary investment responsibility Retains sole fiduciary responsibility and liability 3(21) Shares fiduciary investment responsibility in the form of investment recommendations Retains responsibility for final investment discretion 3(38) Assumes full discretionary responsibility Relieves employer of investment fiduciary responsibility Delegating All of Your Investment Responsibilities The decision to hire an investment manager is a fiduciary function. However, once appointed, a 3(38) investment manager will take on the following duties below, moving them off your to-do list. Development of an investment policy statement (IPS) that defines the strategic objectives for the plan's investments and the criteria that will be used to evaluate investments. Creation of the due diligence process for selecting and monitoring investments for your 401(k) plan. Monitor investment performance against the criteria outlined in the IPS and replace investments when an investment does not perform well or when comparable investments with lower fees become available. When you appoint an ERISA 3(38) investment manager, you have fully delegated responsibility for selecting and monitoring plan investments to the investment manager. Your obligation is to prudently select the investment manager—ensuring they have the credentials and track record to support your plan—and to make certain they are meeting their duties. Responsibilities You Can’t Delegate Because selecting an ERISA 3(38) investment manager and delegating your investment responsibilities provides a significant reduction in your fiduciary responsibilities, ERISA requires that you monitor their work. On a regular basis, carefully review the reports provided by any outside investment experts you hire. In addition to reviewing your plan’s investment performance and fees, you should also identify any issues that arose with respect to investment support. For example: Were there any participant complaints or concerns regarding investment services? If so, were all issues addressed timely and appropriately? Were there any interruptions in participants’ access to investment tools or resources? A more formal and in-depth review of the plan’s outside experts should be conducted periodically to ensure that they are meeting your organization’s needs. Items to consider include: Business Structure: Have there been any changes in business structure or licensing that impact the investment management services being delivered to your plan? Litigation or Regulatory Enforcement: Have there been any recent litigation or regulatory enforcement actions that have been taken against the firm? Modifications in Services: Evaluate notices received from the service provider or changes in practices that have occurred since they were retained. Do these changes impact the level of service you were seeking from the service provider? Staffing Changes: Have there been changes in the staff assigned to support your plan or in the team that manages your plan’s investments? Could the changes have a negative impact on the services provided to your plan? Reasonable Fees: Review the investment fees during the plan year to ensure they were reasonable. Did the actual fees charged match the fees set forth in the service agreement? Do the fees still benchmark favorably against fees charged by other service providers for similar services? Employee Engagement: How many employees have set both short-term and long-term savings goals? How many have provided sufficient demographic information to personalize their savings goals? The Bottom Line on Being a 401(K) Fiduciary Sponsoring a 401(k) plan comes with a complex set of responsibilities, but prudently selecting the right team of outside experts, especially when it comes to investments, can help you manage your responsibilities and potential liability.
A Step-By-Step Guide to 401(k) Plan Compliance TestingA Step-By-Step Guide to 401(k) Plan Compliance Testing Betterment for Business is your partner throughout your 401(k) plan’s compliance testing. We’re excited to work with you and provide resources to keep you informed along the way. We encourage you to review this series of tutorial videos that will help guide you through the milestones of the testing process. Introduction to Compliance Start here. This brief overview walks through the types of compliance tests and how they can impact a 401(k) plan. Your Betterment for Business Compliance Hub This guide shows how to go through your compliance hub, fill out the annual questionnaire, download your plan’s census file, and then re-upload it after you’ve reviewed the file. Annual Census Review This introduction to the census file highlights the key fields to review. Specifically, it covers who should be included within the census, and how to account for employees’ hours worked, compensation, 401(k) contributions and employer contributions. Request Census Information Hours and Compensation Employee and Employer Contributions Action Notifications If your plan has any year-end action items to address, you’ll receive a notification from Betterment. This video covers the types of action items and how to complete them. About Betterment 401(k) plan administration services provided by Betterment for Business LLC. Investment advice to plans and plan participants provided by Betterment LLC, an SEC registered investment adviser. Brokerage services provided to clients of Betterment LLC by Betterment Securities, an SEC registered broker-dealer and member FINRA/SIPC. Betterment LLC and Betterment Securities are affiliates of Betterment for Business LLC. Betterment for Business is an award-winning turnkey 401(k) service that includes plan administration for employers, and personalized, unconflicted investment advice for all plan participants. Powered by Betterment’s smart investment technology, Betterment for Business is one of the most efficient and cost-effective providers in the space, and offers a globally diversified portfolio of ETFs, tax-efficient portfolio management, smart rebalancing, automated investing, fee analysis on synced external accounts, and our retirement planning advice tool. Learn more.