Retirement 101: Non-Discrimination Testing

Retirement 101: Non-Discrimination Testing


There are a lot of benefits that come with a 401(k) retirement savings plan. Not only is it a great incentive to retain employees, but it’s a great way to plan for retirement and save on taxes. However, because of the substantial tax benefits that go with a 401(k), the government has set up a series of annual tests that make sure that the 401(k) plans do not “discriminate” or unfairly benefit individual company owners or the highly-compensated employees.


Non-Discrimination Testing: What Is It?


Every year, the government issues nondiscrimination tests through the Employee Retirement Income Security Act (ERISA) to review the 401(k) plans of the highly compensated employees (HCEs) and the non-highly compensated employees (NHCEs). These tests are in place to ensure that the benefit plans are not discriminating against lower-income employees, and that all the employees are taking advantage of the retirement plan.


Basic Terms:


The HCE is defined by the IRS, as an individual who owns more than 5% of the interest in the company OR receives payment of more than $125,000 if the previous year is 2019; and $130,000 if the prior year was 2020 AND, was in the top 20% of employees when ranked by total compensation. If someone doesn’t meet these conditions, they are an NHCE.


The IRS defines Key Employees as someone making over $180,000 in 2019 OR anyone who owns more than 5% of the business, OR anyone who owns more than 1% of the company and makes over $150,000 for the plan year.


The Actual Deferral Percentage (ADP) Test


The IRS uses the ADP test to compare what the average deferral percentage is by HCEs compared to the average deferral percentage of NHCEs


The Actual Contribution Percentage (ACP) Test


Rather than tracking deferment, the ACP test compares the average employer contributions received by HCEs and NHCEs.


The Top Heavy Test


The Top Heavy Test focuses on a company’s “key employees” and tests the plan’s balance as of December 31st of the previous year (or current year, if it is the plan’s first year). A 401(k) plan will fail under this test if the value of the assets in it’s key employees’ accounts is more than 60% of all assets held in an employer’s 401(k) plan.


Passing The Tests


In order for the companies to pass these tests, the calculations must show that the deferred contributions of the HCEs and the key owners do not significantly exceed those of lower-paid employees. If a company fails these tests, they will be faced with corrective actions, which includes increased taxes and refunding some of the contributions made by the HCEs, or funding contributions to the NHCEs until the tests are passed.


How the Safe Harbor 401(k) Affects the Non-Discrimination Tests


The Safe Harbor 401(k) is a particular type of retirement plan that includes an employer match. However, because of the way the Safe Harbor 401(k) is structured, the plan allows the employer to automatically pass the non-discrimination test or avoid it altogether through the employer allocated contributions. It’s a great option, especially for small businesses, who may find it hard to pass these non-discrimination tests.




Is a Safe Harbor 401(k) Right for You? (2019) Employee Benefits Article. Paychex Worx
Safe Harbor 401(k) Plans: Answers To Common Questions. (2016) By Eric Droblyen. Employee Fiduciary
Safe Harbor FAQ: What Employers Should Know About 401(k) Compliance Testing. (2017). Employee Benefits Article. Paychex Worx
401(k) Plan Fix-It Guide – The plan was top-heavy and required minimum contributions weren’t made to the policy. (2019).Retirement Plans. IRS
What Is a Safe Harbor 401(k)? (2019). By Melissa Phipps. The Balance



How the SECURE Act Effects 401(k)s

How the SECURE Act Effects 401(k)s

How The SECURE Act Affects 401(k)s

Recently, Congress passed one of the largest changes to the retirement plan industry in a decade.

The Setting Every Community Up for Retirement Enhancement Act, also known as The SECURE Act, has been years in the making.

The SECURE Act covers a lot of territory for retirement plans and 401(k)s and it’s fairly clear that the objective was to motivate employers to offer a retirement plan to their employees in order to give them an easy way to start saving for their retirement.

Below, we cover 3 main areas of how The SECURE Act affects 401(k)s through tax-credits, extensions, and increases.

Increase In Tax-Credits

Previously, employers who had implemented a 401(k) for their company received a flat $500 tax-credit.  For many, this wasn’t enough incentive to offer a 401(k) plan due to the associated costs of administration.

Under The SECURE Act, employers will enjoy a minimum of $500, with a maximum of $5,000 for up to three years.  The final amount depends on how many employees sign up for the plan. With each eligible employee, whether they participate or now, the employer will receive a $250 tax-credit, no less than $500.

Unfortunately, the calculation does not include Highly Compensated Employees, also known as HCEs.

In addition, The SECURE Act offers an additional $500 tax-credit for those 401(k) or Simple IRA plans who use automatic enrollment for their participants.

Automatic enrollment, often called auto-enrolment, shifts the process of the employee from opting into a plan to opting OUT of the plan.  The idea behind this is to urge the employees to make a quicker decision on their retirement savings.

Often, employees want to sign up for the plan, but never actually sign up because of a hectic work or family life.

Extension of the Implementation Deadline

This is another significant change derived from The SECURE Act.

Employers now don’t need to worry about a December 31st deadline to decide if they want to implement a 401(k) or Cash Balance plan. They now have up until their tax filing date (including extensions) to decide whether they would like to implement a plan for the previous year.

Simply put, this is a tax play, but be careful, as the employee deferrals portion likely won’t be able to be made retroactively since W-2’s will already be filed.

Previously, if you wanted to get any tax deductions through 401(k) contributions for the current year, you would need to start the retirement plan by the end of that year.  With the passing of The SECURE Act, employers are now able to contribute up until the filing date for the previous year.

This rule goes into effect for plans starting in 2020 for the 2020 tax year.

This won’t be eligible for the 2019 tax year.

Eligible Part-Time Employees

Prior to the passing of The SECURE Act, employers could exclude part-time employers when offering a 401(k) plan for their company.

Now, employers are required to maintain dual eligibility requirements in order to include their part-time employees.  This means that along with their eligibility requirements they set for full-time employees, they are allowed to have a second set of eligibility requirements for their part-time employees.

The rules for part-time employees can be either of the following:

  1. The employee is required to complete one year of service with at least 1,000 hours.
  2. The employee is required to have at least 500 hours of service for three consecutive years.

If the employee completes the latter, then the employer is able to exclude them from any nondiscrimination and coverage rules.  This helps with distributing excess contributions to HCEs. Employers can always be more generous and include part-time employees and have shorter eligibility, but many small businesses choose not to to help lower costs.

In Summary

We see the passing of The SECURE Act as a positive for small businesses.

These incentives give the employer a way to offset the costs associated with a retirement plan that helps with recruiting high-quality employees, employee retention, and tax management.

Contact us for a free consultation or head over to the Retirement Plan Evaluator to see which plan is best for your business.

How Often Should You Be Benchmarking Your 401k, and Why You Need to Know

How Often Should You Be Benchmarking Your 401k, and Why You Need to Know

The Department of Labor requires you to benchmark your 401K at least once every three years, but it’s actually recommended that you benchmark your 401K more frequently. Benchmarking is important because you’ll need to evaluate your current 401K plan against other options to ensure that you’re adhering to best practices. In order to avoid fiduciary liability, most experts suggest it’s important to benchmark your 401K every 1-2 years.

Why is benchmarking so important?

Benchmarking protects you and your employees and is required by law by the department of labor at a minimum of once every three years. Benchmarking practices are in place to ensure that the retirement plan that you offer your employees has appropriate investment options and fees that are not unreasonable. By benchmarking, you’ll be comparing your 401K against other plans to ensure that you’re within your legal bounds and providing your employees with the right options.

Why benchmark more frequently than the required minimum?

Because your business is not stagnant and changes over time, it can be important to benchmark every 1-2 years to make sure your plan remains appropriate. Standards for how a 401K should look change based on things like the size of your business. As your business grows, it’s important that your retirement plan keeps up.

Your benchmark report is an important tool for protecting your business. Adhering to best practices by benchmarking every year to two years will ensure that you’re not caught unprepared, and this will safeguard you as your business changes and grows. Benchmarking at this slightly increased frequency will also ensure that you’re never on the wrong foot with the Department of Labor, and it’s incredibly helpful to have a clear assessment of how your 401K is evaluated when compared to other similar plans.

For more information on how we can help you with your businesses’ needs contact us today.

4 Ways to Tell Your Company is Ready for a 401k

4 Ways to Tell Your Company is Ready for a 401k

If your business is not offering a retirement plan, you’re missing out on a lot of benefits. It’s not only suitable for your employees but also for you as a business owner.

You might be reluctant to offer a 401k plan due to concerns on issues related to administration, costs, and compliance. If you’re wondering whether your business is ready to adopt a 401k plan, below are a few things you need to look out for that will tell you it’s time to dive in.

1. Potential and Current Employees are Asking for Benefits

Most prospective employees will ask if your company has a retirement plan of any kind. If you don’t have a plan in place, you run the risk of them searching for employment elsewhere. If those in your current workforce are starting to have families of their own, having a retirement plan becomes that much more important to them.

It will help you attract an exceptional workforce while rewarding current employees resulting in increased retention.

2. You’re Looking for a Tax Break

Paying a lot of taxes is not something that makes any business owner happy! If you’re paying a lot in taxes, consider a retirement plan. In some cases, gains accumulated inside a retirement plan are not subject to tax.

3. You Haven’t Started Saving for Your Retirement

Even as a business owner, you might not be ready for retirement. If you don’t start saving soon, you will not have enough money to retire. According to Financial Samurai, you need to save 10 to 15 percent for about 40 years to live at your current lifestyle after retiring.

4. You Have Excess Cash at The End of The Year

Now your business is doing great. You might be wondering what you should do with all the extra money. If your company has excess cash, there are several ways you may want to invest, which include putting it in a 401k plan.

It will help you get to your goals faster than you expected. If you haven’t been hitting your contributions limits, you have the chance to do so.

Get a Retirement Plan

Establishing a 401k retirement plan is a long-term commitment to your company and your employees. It doesn’t have to be complicated! The choices you make for your business will impact the kind of talent you retain and their satisfaction.

Contact us today to get insights and assistance in choosing the best retirement options for your company.




What it Means to be a Prudent Investment Steward

What it Means to be a Prudent Investment Steward

The most heavily scrutinized fiduciary duty of a plan sponsor is its role as an Investment Steward, which also extends to members of the plan’s investment committee, trustees, and anyone else who is involved in the oversight of investment decisions for the plan. Understanding the role and all of the requirements attached to it by all of the various regulatory bodies (the S.E.C., the DOL/ERISA, UMPERSA, UPMIFA, etc), is crucial for any plan sponsor that hopes to operate safely and effectively within the bounds of legal and ethical laws and expectations. By adopting best practices, plan sponsors can not only assure that its requirements as an Investment Steward are met; they can ensure the best possible outcome for the plan’s beneficiaries – their employees, whose best interests are paramount in all decisions.

What is exactly is an Investment Steward?

At its core, an Investment Steward is anyone who is connected to the selection, management and monitoring of plan assets, and can include the plan sponsor, trustees, investment committee members, and legal counsel for the plan. Typically, these individuals are not investment professionals unless they are a fiduciary advisor; however one of their principle responsibilities is the selection and oversight of the plan’s investment advisors and managers.

Prudence is the Primary Measure

The standard by which Investment Stewards are measured is their strict adherence to a sound process in assembling, evaluating, and acting upon pertinent and reliable information in a manner that follows widely accepted investment theories. The Investment Steward’s liability is limited when there is clear evidence that procedural prudence was followed in determining the appropriateness of investment options and products selected for plan participants. However, continual due diligence of the plan’s investment portfolio, in terms of its performance, costs, and its appropriateness for plan participants is also required in fulfilling fiduciary responsibilities.

Meeting the test of procedural prudence in the management of investment decisions is challenging, even for experienced investment managers. Investment Stewards, be they plan sponsors, trustees or investment committee members, must rely on a structured set of best practices that fosters shared fiduciary expectations among each other as well as with the plan’s service providers. However, the ultimate fiduciary responsibility of plan prudence will always lie with the plan sponsor.

The Benefits of Best Practices for Investment Stewards

The stakes for plan sponsors are high; however, the benefits of effective and efficient plan implementation can far outweigh the costs; except when fiduciary responsibilities are breached, which can trigger expensive claims and litigation. With a deliberate, structured adherence to best practices for Investment Stewards, plan sponsors can significantly reduce their exposure while increasing the plan’s effectiveness and efficiency.  The benefits of fully adopting a best practices framework include:

Risk Mitigation: In plan management, it’s typically not what was done that triggers a claim; it’s invariably something that was not done which can result in a breach of fiduciary duties. Following procedural prudence through a “checklist approach” – much like a pilot’s checklist – ensures that everyone involved stays on the right course.

Sharpening Fiduciary Competence: As part of the evidence of procedural prudence Investment Stewards must demonstrate, they must be able to demonstrate the skills and knowledge required in fulfilling their fiduciary duties, which includes investment awareness and a clear understanding of oversight role in ensuring all parties are working in concert to serve the best interests of their plan participants.

Improved Cost Effectiveness: Successful businesses have clearly demonstrated the effectiveness of following a regimented model built on a framework of best business practices. Plan management is no different, especially when it requires a new or additional set of competencies to achieve success. For any business objective, the shortest route to a successful outcome achieved with optimal cost effectiveness is, by simply implementing proven, best practices and principles.

Whether a plan sponsor is in the startup stage, in the process of reviewing their plan, or approaching a critical juncture of expansion, seeking out and adopting a best practices framework for Investment Stewardship should be paramount in its approach going forward. The time, effort and cost in doing so may seem disproportionate to the benefits at the outset of implementation; however, they are minimal in comparison to the benefits of risk mitigation, mastering fiduciary roles, and plan effectiveness and efficiency in the long run.



Safe Harbor 401k with Age-Weighted Profit Sharing: A Win-Win for Businesses

Safe Harbor 401k with Age-Weighted Profit Sharing: A Win-Win for Businesses

For many small businesses comprised of one or several highly compensated employees and a few non-highly compensated employees, the Safe Harbor 401k plan may be the best option if maximizing contributions is a primary objective. Safe harbor plans effectively remove the barriers of discrimination testing that limits the amount that can be contributed for highly compensated employees. However, what if the objective is to be able to contribute the maximum amount allowable under the tax code? That’s where a combination safe harbor/profit sharing plan can be the ultimate solution for maximizing the retirement savings opportunities for business owners and their highly compensated employees.

How Does a Safe Harbor-Profit Sharing Plan Work?

A Safe Harbor 401k plan is a 401k plan alternative for smaller businesses that seeks to weigh their contributions more heavily to the owners and/or highly compensated employees. Essentially, the plan requires a prescribed employer contribution be made on behalf of all employees and they must be 100 percent vested. With that, employers can skirt the testing for contributions required of regular 401k plans – otherwise referred to as a “safe harbor.”

These plans are well-suited for smaller businesses with less than a half dozen employees which are weighted more towards the highly compensated. While it’s a significant step towards increasing their contribution capacity, it still leaves a significant amount on the table.

Adding an Age-Based Profit Sharing Plan

An age-based profit sharing plan is generally compared to a defined benefit plan that allows discretionary contributions. Factors such as age, retirement timeline, and length of employment are considered as part of the formula for allocating contributions. So, in businesses where the owners or key employees are significantly older than the other employees, it can favor the former while not being discriminatory against the latter. That’s because the contribution amount is based on projected benefits an employee can expect to receive at retirement. The closer an employee is to retirement, the higher proportion of employer contributions he or she can expect to receive.

In a simple example, an owner and his wife, both 48, earning $250,000 and $100,000 respectively could increase their total contributions substantially by combining a Safe Harbor 401k plan with an age-based profit sharing plan.

Under a normal plan rules, the owner and his wife could contribute up to $18,000 and receive a 4 percent employer match bringing their total contributions to $27,800 and $22,000 respectively.

By adding a profit sharing component, they could receive an additional contribution up to his 415 limit of $53,000 (2015 limit) and his wife’s total to $35,877. In doing so; however, they would have to include eligible employees in the profit sharing contribution.

Based on profit sharing calculations, they would have to make a contribution of approximately 7 percent on behalf of their three employees earning $41,000, $36,000 and $32,000.  Based on a total payroll of $109,000, the 4 percent match made under the 401k plan would amount to just under $4,400. The additional 7 percent profit sharing calculation would add $7,630, bringing their total exposure to just over $12,000. However, this additional investment will enable the business owner and his wife to increase their contributions by more than $40,000. The additional tax savings realized by the business partially offsets the increased investment.

In the right situation, the Safe Harbor 401k – Profit Sharing arrangement is a win-win for the business and its employees. And, because profit-sharing contributions are not mandated, businesses enjoy the flexibility to adjust their contribution strategy according to its changing circumstances. Although it does require plan design, administration and reporting, the benefits to the business, key employees and employees invariably outweigh the costs.