401(k) Plan Design Review

Written by Scott Emering

The final year of your tri-cycle restatement period provides an opportunity to review and reassess 401(k) documents. It is an especially good time to look at these key features:
• Employer Contributions
• Automatic Features
• Roth 401(k)
• In-Service Distributions
• Joint & Survivor Annuities

We are approaching the final year of the Tri-Cycle Restatement period (due July 2022). This is a great opportunity for plan sponsors and committees to review and if needed, amend their 401(k) plan documents to ensure they are still meeting company goals and objectives. Whether that’s preparing employees for retirement, attracting talent, maximizing tax deductions or a little of all the above, now is the time to speak with your RSG consultant about specific plan design provisions that can help you get there. This article highlights some key areas of focus for business owners and 401(k) committees.

Employer Contributions

At RSG, we are often surprised when we take over new plans and find their total employer contributions are either close to, or at the levels of IRS Safe Harbor requirements. This could be a match that was targeted 3 –4% or a profit sharing pro rata allocation that was around 3%. So funding is virtually the same, but by not utilizing the safe harbor protections you create much more in the way of DOL discrimination testing. With a few modest changes, the plan can take advantage of the restatement opportunity to eliminate non-discrimination testing issues. Note, for existing plans safe harbor features can only be turned on at the beginning of the plan year and require a 30 day notice.

But even if that’s a “bridge too far”, sponsors should at least review their current match and profit sharing formulas to make sure their offering is competitive and in line with objectives.  Recent trends include “stretching” the match to encourage participants to save more – so instead of matching 50% of the first 6% (very common), you stretch that to 50% of the first 8%, etc. 

Automatic Features

These features have been around for a while but have become more popular over the last 5 years as the success stories pile up.  If you are struggling to get participation, auto-enrollment will address the issue in a meaningful way.  You are essentially reversing the participant decision process from “do this if you want to join” to “do this if you do not want to join”.  The result is usually 80%+ participation rates.

Maybe you already have auto-enrollment and have seen the uptick in participation but are finding all your participants are stuck at that initial sign-up deferral rate – usually around 3% of pay.  It’s a great start, but not likely to build up a significant nest egg.  Adding an auto-escalation feature with an increase in savings of 1% per year until you hit a cap of say 10%, is a good way to address this inertia.  Even better if it follows or syncs with a new “stretch match” designed around that same objective.

It is also important and timely to note, that there are tax incentives available for turning on features such as Auto-Enrollment and Auto-Escalation thanks to the Secure Act. So make sure that this is part of your discussion and analysis. For many who were close to moving in this direction, these tax incentives helped move the needle to a yes.

Roth 401(k)

Most of the plans we administer at RSG offer a ROTH 401(k) feature.  This allows participants to put away after-tax funds and both the principal and earnings are then tax free at retirement.  This can make a lot of sense for young participants who are in a lower tax bracket now or for high earners who do not qualify for a ROTH IRA – there is no income limit for high earners with a ROTH 401(K) contribution.

Some, but not as many, offer the ability of an in-plan ROTH conversion.  This allows you under certain circumstances to convert existing tax deferred accounts to ROTH accounts without having to rollover funds out of the plan to an IRA first. 

RSG believes that having ROTH assets in the plan can be an important tax hedge for everyone in retirement – who knows if rates will be higher, lower, etc. at various points of your retirement.   You can find out more about ROTH 401(k) from our recent blog on the subject Click Here

In-Service Distributions

The IRS allows in-service distributions from 401(k) plans at age 59 ½.  Rollover contributions are allowed to be withdrawn at any time.  But these provisions need to be allowed in the plan document.  Most do, but the restatement is a good time to confirm you have these options in place. 

It’s particularly important if you have an older workforce.  That’s about the age where participants really start planning for retirement and they may want to consider investments or products outside the scope of the plan.

One important counter point for this discussion, and why true consulting is always a discussion instead of a direction. What happens to plan pricing and impact on employees as a whole if a handful of key executives withdraw large rollover balances significantly reducing plan assets and average participant balance? This needs to be part of any thoughtful analysis.

Joint & Survivor Annuity

This legacy provision is a holdover from the defined benefit plan days.  But 401(k) plans that allow a lump sum are not required to offer an annuity option.  Yet many plans we review still have this language.  And while the laws are changing to make it safer for sponsors to offer an annuity option, you are still on the hook to find one if a participant elects this payout type.  In addition, plans that offer an annuity option must also obtain spousal consent for withdrawals and loans which slow down the fulfillment process.

A Fiduciary Oversight Committee

The most important step every for every business is to have an informed and prudent process around their plan. That consists of forming an internal committee, acting as a co-fiduciary, and supporting all aspects of plan consulting. This oversight committee operates with the goal to move beyond simply having a plan, to thinking of it as an asset of the organization that can be leveraged to hire people, retain, and of course accrue wealth. At RSG this is common practice. Our Relationship Managers work with organizational committees and run trustee meetings throughout the year. At those meetings we track plan health metrics, benchmark funds, benchmark fees, and track participant behaviors (loans, distributions, deferral/participation rates, and investment allocations to constantly be trying to improve the plan.

While our goal at RSG is to make the restatement process simple and easy for clients, it is also a great opportunity to speak with your RSG Plan Consultant to revisit, upgrade and/or modernize your plan.