(614) 396-7652 info@lifeincrs.com
How Does Annual 401(k) Non-Discrimination Testing Work?

How Does Annual 401(k) Non-Discrimination Testing Work?

A 401(k) plan is a complex business management aspect that most small and medium-sized businesses struggle with. Non-discrimation testing just to mention one.

There’s a lot to understand, from confusing legal terms to strict regulations that are hard to follow when setting up or adjusting your 401(k) plans. In fact, 401(k) non-discrimination testing is one hurdle you will face as a business and plan sponsor. 

Failing the tests could result in tax penalties, refunds, and fines— which you were not prepared for.

Knowing how 401(k) non-discrimination tests work will help you understand how to remain compliant and save you an extra load of costs. 

What is 401(k) Non-Discrimination Testing?

401(k) non-discrimination tests(NDTs) verify that all employees, regardless of their compensation and matching contributions, are benefitting fairly from a 401(k) plan. In other words, 401(k) NDTs look at how much of their salaries employees defer and how much employers contribute as matching, and the percentage of assets in the plan that belong to key employees. 

The goal of the 401(k) annual tests is to ensure that a plan doesn’t discriminate against other employees in favor of highly compensated or key employees.

Not sure which plan is for you, check out our Retirement Plan Evaluator to learn in 30-seconds.

 

what is a mega backdoor roth 401k

Who Mandates the 401(k) Annual Compliance Tests?

The 401(k) annual tests are governed by ERISA— a set of regulations and laws related to employee retirement benefits and administration. These laws are then implemented by the Internal Revenue Services(IRS). 

The IRS sets guidelines and updates the requirements on NDTs, such as who classifies as a HCE or NHCE. Under IRS guidelines, a Highly Compensated Employee (HCE) is one who:

  • Owned more than 5% of the business interest during the year or any preceding year regardless of the compensation amount.
  • Accrued a compensation of more than $130,000 if the preceding year is 2020 or 2021 and if an employer chooses, was in the top 20% of employees when ranked by compensation.

Any employee that doesn’t fall under this classification is known as a non-highly compensated employee(NHCE)

It’s a business’s responsibility to ensure they pass the 401(k) non-discrimination tests. A business can either leave the testing process to an in-house team or, as in most cases, bring in a qualified third party.

 

The Main Types of 401(k) Annual Tests

Annual 401(k) non-discrimination tests are of three types: The ADP, ACP, and Top-Heavy Test. All three aim to ensure fair benefits of a 401(k) plan to both HCE and NHCEs.

1. The Actual Deferral Percentage Test(ADP)

This test compares the average salary deferral percentage of highly compensated employees and that of non highly compensated employees. An employee’s deferral percentage is the percentage of compensation they contribute to a 401(k) plan. 

 

When calculating the ADP, you take total employee 401(k) contributions divided by their total compensation of the calendar year. You won’t include catch-up contributions in the calculations. The HCE and NHCEs deferred percentages are then averaged to determine the ADP of each subset.

For your plan to pass the ADP test as per IRS guidelines, you should ensure that:

  • Where the ADP of NHCEs is 0%-2%, the ADP of HCEs should not be more than 2 times the NHCE rate.
  • If the ADP of NHCEs is 2%-8%, the ADP of HCEs should not exceed the NHCE rate by more than 2%.
  • If the ADP of NHCEs is more than 8%, HCEs’ ADP must not be more than 1.25 times the rate of the NHCE.

(Note: The ADPs described above are in averages)

2. The Actual Contribution Percentage (ACP) 

The ACP test is similar to the ADP, but instead of focusing on what percentage an employee defers, ACP concentrates on employees’ total contributions. Hence, during calculations, you would include the employer’s matching contribution and after-tax contributions. To calculate the ACP, divide the amount of an employee’s total contribution by their w-2 income. 

What Happens if Your Plan Fails the ADP/ACP Tests?

The IRS won’t impose any penalties on a plan sponsor if they fail a test, as long as they take corrective actions on time. By timely, we mean that remedial action should happen the year after testing by either 30th June for EACA plans and 15th March for ACA plans. 

Not taking corrective action by the stipulated deadlines can result in additional and unplanned contributions, double taxations, and in extreme cases, plan disqualification.

What Corrective Action Should YouTake After Failing ACP/ASP tests?

Plan sponsors can either:

  • Refund excess contributions to HCEs

This will bring the HCEs contributions down to reach the test limits. The refunded contributions will be taxable in the year when they are distributed.

  • Make Qualitative non-employer contributions (QNEC) to all NHCEs

Employers can either target NHCEs with the lowest deferrals first or contribute the same amount to all NHCEs.

3. Top Heavy Test

This test focuses on key employees as opposed to HCEs. According to the IRS, a key employee is:

  • An officer making over $185,000 as of 2021
  • A person who owns 5% of the business
  • An employee owning more than 1% of the business and making over $150,000 for the plan year.

When is a Plan Considered Top-Heavy?

A top-heavy plan is classified as one where key employees’ assets make up more than 60% of the total assets in a plan. The goal of the top-heavy test is to ensure that NHCEs receive a minimum benefit where a plan is top-heavy.

What to do When Your Plan is Top-Heavy?

If a plan is top-heavy, you’ll need to contribute 3% of compensation for all non-key employees in employment as of the last day of the plan year. The contributions made will be subject to a vesting schedule where participating employees will be 100% vested after 3 years.

If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.

 

How Does Annual 401(k) Non-Discrimination Testing Work?

How to Navigate Annual Testing with a Safe Harbor 401(k)

Is there a way to avoid these legally intensive tests? Yes. You can be exempted from a 401(k) non-discrimination test with a safe harbor 401(k).

The safe harbor plan provides all eligible employees with a fixed, mandatory matching contribution from the employer. In exchange, your business can avoid the annual non-discrimination tests set by the IRS.

Annual 401(k) non-discrimination tests can often set your business back with paperwork and expenses. However, by monitoring where you stand periodically and encouraging NHCEs to contribute to a 401(k) plan, you can make the necessary adjustment in time to pass the tests.

If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.

What Do Employees Value More: Higher Pay or Better Benefits?

What Do Employees Value More: Higher Pay or Better Benefits?

Recruiting is increasingly becoming hard nowadays, and even after hiring employees, retaining them is becoming an even bigger challenge.  So, what do employees value more, higher pay or better benefits?

A study shows that three million American employees quit their job looking for something better every month. Therefore, companies are actively looking for ways to step up the recruitment and retention of their workforce.

However, most employers are torn between increasing employee earnings and offering improved benefits. So, which works best in recruiting talents and keeping employees? Which is the better incentive for prospective and current employees?

This post discusses the pros and cons of both higher pay and better benefits to help you choose the best recruitment and retention strategy for your company.

Pros of Providing Higher Pay

1.    Attracts Top Talent

Although higher pay alone might not be effective in attracting top talent, it has an influencing power. Even as employees search for companies with better benefits, most of them are also keen on salary; therefore, higher salary helps recruit high-level employees.

2.    Gives High Output Levels

Giving higher pay sends a message to employees that you expect a higher level of output. When employees realize they are earning way above their counterparts in other companies, they are likely to put more effort. They work hard to prove that they deserve the pay and help your company achieve its goals.

3.    Employees Retention

A well-compensated workforce is more likely to stay in a job for a longer time. Even job offers with stated salaries are not likely to lure them since they are already getting high pay. Higher employee retention means you won’t spend time resources in recruiting and hiring new employees.

Cons of Higher Pay

1.    Reduced Business Revenue

Although higher pay can be effective in attracting top talent and retaining them, it impacts business revenue. It increases your business expenditures, and the higher compensations you give may not translate into more profits, especially in the short term.

what is a mega backdoor roth 401k

Pros of Better Benefits

1.    Attracts Top Talent

Improving your benefits package is a smart move when you want to hire top talents to help your company reach its goals. In fact, most businesses have realized the power of employee benefits in attracting well higher-level employees and are leaving nothing to chance.

Unlike in the past, where a fat check was enough for an employee to hop from one company to another, benefit programs are also a major deciding factor when choosing where to work today. Giving better benefits shows that you have the corporate goodwill to invest both in your business and workforce. This attracts high-level employees.

2.    Reduces Employee Turnover

The battle does not end at hiring, but you also need to keep the employees. Benefits have a key role in retention since they cushion your workforce from being swayed by job offers from other companies. Employee turnover is expensive and can even lead to an employer doubling the salary to fill up the position, resulting in unexpected expenditure. Offering better benefits help reduce turnover, which saves your company expenses on hiring and training.

3.    Tax Advancements

Offering benefits may give you an advantage of tax reduction. These tax deductions are available for benefits such as a 401k match, pension contributions, insurance options, and more. The tax advancement helps your employees to incur minimal taxes, thus improving their financial savings. This facilitates employee growth and also increases your company’s profits.

Cons of Better Benefits

1.    It does not satisfy everyone.

Employees have different tastes, and benefits will not satisfy everyone. You could have the best and most competitive benefits in the region or industry, but still have some employees who are not satisfied with the package you offer. Therefore, the benefits could be there but fail to motivate some employees.

2.    Fluctuating Costs

If you offer comprehensive health insurance benefits, keeping up with fluctuating costs could be a challenge. For example, there has been a rapid rise in the cost of health insurance which forces companies to either cut the benefits or pay more to maintain the package.

3.    Legal Issues

Some benefits have a specific manner in which you can provide your employees. Your business might have to pay legal fees to verify that your benefits packages are as mandated by various business laws.

Besides, mistakes in giving the benefits could open doors for litigation. Employees may sue a company due to errors or failure to give promised benefits. All these legal issues might make giving employee benefits a delicate affair for companies.

Popular Benefits

1.    Health Insurance

Even with the younger generations increasingly filling the workforce, a robust health insurance is recognized among the most popular of benefits packages for employees. Ensuring that your workforce has a comprehensive health insurance plan that covers deductible is essential. It is an assurance to employees that they don’t have to worry about injury or illness.

2.    401k & Retirement

A 401k retirement plan is another popular benefit in many companies. A competitive 401k match increases job satisfaction and makes your organization stand out amongst competitors. It makes the team feel that you value their financial future.

Outside-of-the-Box Benefits

Out of box benefits are available in different forms, from eliminating stress in employees’ daily lives to self-development for better opportunities.

1.    Paid Time-off

Paid time off is valuable to most employees. Employers encourage employees to take paid time off for covering child care needs, vacations, and even preventive wellness such as screenings.

2.    Tuition Assistance

Considering the financial burden that employees who want to further their studies or those with college-bound children may face, employers are providing tuition assistance as a benefit. Relieving your employees from the stress of meeting the education costs through tuition reimbursement is a great package to see them want to keep working with you.

3.    Work Flexibility

As organizations increasingly embrace remote working, some employers are providing their workforce with work from home benefits. Some are even reserving work from home for emergencies, such as when an employee can’t make it to the office. These flexible arrangements have a role in making people want to work with your organization.

With all the difficulties employers are experiencing today when hiring, any thought of employee quitting may leave you terrified. You doubt whether you can find a suitable replacement in record time to avoid disrupting your business operations.  

Having read the above post, you now know how higher pay and better benefits can impact your employee recruitment, retention, and your overall company. The secret lies in recognizing that the two are not mutually exclusive but complement each other. Both have a significant impact on how you attract and retain top talents.

If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.

What is a Mega Backdoor Roth 401k

What is a Mega Backdoor Roth 401k

Maybe you’ve heard of a mega backdoor Roth 401k already.  But, how do you navigate creating one as an employer with employees?  Read below as we answer the question, what is a mega backdoor Roth 401k, and how to navigate it as an employer.

Saving for retirement is complicated, and the most common vehicle is a traditional 401(k). However, these plans result in the tax being deferred until retirement.

Because of this, some people prefer a Roth IRA or Roth 401(k), where you put the money in after paying tax on it. The distributions are then tax free. A tax advisor will generally tell you which option is going to work best.

There are also various ways to combine these options in an advantageous way. One of these is the mega backdoor Roth, which allows people with a good amount of savings to add a lot of money to their Roth IRA quickly.

What is a Mega Backdoor Roth 401k?

First of all, let’s talk quickly about what a backdoor Roth is. In order to have a Roth IRA, you have to have income below certain levels. In 2021, those levels are $140,000 for a single person or $208,000 for a couple filing jointly. If your income is above that limit, you can’t contribute to a Roth IRA.

What you can do is create a traditional IRA, put your money in it, then convert it to a Roth IRA. You will have to pay taxes on any gains the money made while in the IRA and repay the tax deduction. Ideally, what you do is put the money into the traditional IRA then immediately transfer it to the Roth.

So, a mega backdoor Roth is…doing this on a larger scale. It’s what you do when you have maxed out your contributes to both your 401(k) and your Roth IRA. First of all, your 401(k) plan has to allow after-tax contributions and let you move that money to a Roth IRA.

Not all employer plans do this, and employers should be ready to potentially be approached about this by their highest earners.

What you do is put in the maximum post-tax contribution, which is typically $58,000 in 2021. This is after your and your employer’s normal contributions. I.e., you put in all your after-tax savings and then immediately transfer those to the Roth IRA (or roll them into a Roth 401(k)) before they start making money.

You can also roll the contributions into a Roth IRA and the investment earnings into a traditional IRA. Yes, the IRS says this is okay. What the IRS doesn’t like is you rolling only after-tax amounts over. You have to also move across an equal amount of the pre-tax amount…although you can move it right back.

This is an option for you and your highly compensated employees, but there are some things to think about.

what is a mega backdoor roth 401k

Who Benefits from a Mega Backdoor Roth 401k?

The mega backdoor Roth is an option for high earners who are able to save substantial amounts of money. Typically, you can move up to $38,500 into a Roth IRA this way. As it’s advantageous to max everything out first, you can see that this is the kind of thing available to C-suite executives and other high rollers.

You should also talk to your tax advisor first, as it may not be the most advantageous use of that money. It may, for example, be a poor strategy to do this when you have debt you could pay off. Most advisors suggest also maxing out your HSA if you have one, as well as your kid’s saving accounts. Bear in mind that you do not get an immediate tax benefit from doing this.

Basically, this is a great way to increase your retirement savings, but is not something you should do until you have taken care of your other key financial goals. Always talk to a tax advisor before deciding between this and other potential options such as taxable investment accounts or a Roth 401(k).

Is the Mega Backdoor Roth 401k Going Away?

Quite possibly. Congress sees this as a loophole that allows higher earning individuals to avoid paying taxes. It’s also seen as something that is done only by the ultra-wealthy.

Because of this, the House Ways and Means Committee is proposing prohibiting all employee after-tax contributions in qualified plans and converting after-tax IRA contributions to Roth. This would affect people below the $400,000 level below which Biden promised not to raise taxes, so it’s possible it won’t happen or will be offset by other changes to the tax code.

If you happen to have the kind of savings that would warrant using the mega backdoor Roth this year, you should absolutely consider doing so as it may be gone by the end of 2022.

It would also close the regular backdoor Roth IRA, denying people who have gone above the income level the ability to continue to contribute to a Roth IRA.

    What Should Employers Think About?

    If you have high earning employees, they might want to take advantage of the mega backdoor Roth. For them to do so, your plan has to be set up to allow both after-tax contributions and in-service withdrawals.

    Also, it is actually beneficial for people using this loophole for you not to match contributions. However, you can’t treat people at different income levels differently when contributing to plans, so in order to help them out with this you would have to impact your lower-salaried employees as well. Thus, it’s something to be careful of; you can’t lower the CEOs contributions so they can use the mega backdoor without potentially getting into trouble with the IRS.

    However, allowing after-tax contribution on its own can prevent the plan from passing the non-discrimination test. That is to say, it allows highly compensated employees to contribute more than the IRS limits, which is why many employees don’t allow this.

    Allowing it just so that your highly compensated employees can take advantage of a loophole breaks not just the letter but likely also the spirit of this.

    The mega backdoor Roth is something that some business owners can take advantage of, but you have to be very careful to avoid breaking IRS rules on retirement accounts. 

    For employers, it is a strategy that carries some IRS risk from allowing after-tax contributions or potentially treating highly compensated employees favorably. Finally, there is a very real chance this strategy is going away. Some people may want to take advantage of it this year ahead of potential legislation.

    If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.

    What Is An HCE And How Does It Affect Your 401k Plan?

    What Is An HCE And How Does It Affect Your 401k Plan?

    Many employers offer 401k plans to their employees for varying reasons. However, the major incentive for starting one is the plan’s tax deferral benefits, which allow high contribution limits.

    The current contribution limit for 2021 reaches up to $19,500 for employees under the age of 50, which was the same for 2020. The total contribution limit, including employer contributions, increased from $57,000 in 2020 to $58,000 in 2021. In addition, employees over age 50 and above can bump up their savings through a catch-up contribution with a limit of $6,500, which is unchanged from 2020. 

    401k plans can be beneficial for employees in growing their retirement savings, especially if the employer is generous with the matching contributions. By March 31, 2021, 401(k) plans had assets valued at approximately $6.9 trillion in assets and made up almost one-fifth of America’s retirement market worth $35.4 trillion.

    But, there are existing rules which limit plan contributions. Employers have to be aware of how to manage their plans and especially when they have highly compensated employees on their payroll.

    The Internal Revenue Service (IRS) clearly defines what an HCE is and outlines the provisions of non-discriminating tests which employers must take every year. Compliance is required of employers and their employees to avoid facing IRS penalties.

    What is an hce

    What Is an HCE?

    A Highly Compensated Employee (HCE) has to meet two criteria according to the IRS. The first rule is that they have over 5% ownership in the company providing the plan at any time in the current year or previous year. The second rule is that their earnings amounted to $130,000 or more from the firm if the previous year was 2020 or 2021. And also, if they were in the top 20% of the rank in compensation, if the employer chooses.

    The set conditions for an HCE are a part of the non-discrimination test which the IRS requires all 401k plans to undertake annually. The test divides 401 k contributors into two; non-highly compensated employees and highly compensated employees to ensure equal benefits for all employees in the company.

    Employers pass the test if the average contributions of HCEs do not exceed 2% of the average contributions of non-highly compensated employees (NHCE). Previously, there were no limits on the contributions by highly compensated employees, meaning their contributions could be higher, equally earning them higher tax benefits.

    It is important to note that just 5% ownership does not translate to being an HCE, but it starts from a 5.01% share. In addition, spouses can combine their shareholding to meet the threshold provided they work in the same company. The shares of the employees’ children and grandchildren working in the same company also count.

    For clarity, compensation referred to in the second criterion includes basic salary, bonuses, overtime, commissions, among others, including 401k plans.

      Why It’s Important

      The purpose of the non-discrimination test is to ensure all employees receive equal benefits. This acts as a move to inspire any HR professional working in an organization where the ratio of top executives to employees is unbalanced. This means even low-earning employees have an equal chance to grow their retirement plans. Passing the nondiscrimination test is especially important for a company with HCEs or they risk facing penalties from the IRS and other administrative challenges.

      There are three main tests to determine if a plan is discriminating:

      1. Actual Deferral Percentage (ADP)

      This test makes a comparison of the average deferral rates (Pretax and Roth deferrals) of both highly compensated and non-highly compensated employees. ADP is a percentage of the employee’s compensation deferred to the 401k plan. A plan passes the test if the average deferral of the HCE does not exceed 125% of the average deferral of a NHCE. Alternatively, it passes the test if the HCE deferral rate is not more than the lesser of 200% of the average deferral rate of an NHCE or the average deferral rate of the NHCE plus 2%.

      2. Actual Contribution Percentage (ACP)

      It applies similar tests as ADP but compares the average employee contributions of both HCEs and NHCEs.

      3. Top Heavy Test

      This targets key employees, and compares their assets with all the assets under the plan. The plan fails the test if the value of assets in the accounts of key employees exceeds the value of total assets in the plan by 60%.

      The general rule for a nondiscriminatory plan is that HCEs or top employees do not access more benefits from the plan, and that a good number of non-HCEs participate in the plan.

      What is an hce

      What to Do If the Plan Fails the Test

      There should be no worry if the plan fails the test as there are corrective actions to take. At the minimum, any excess contributions will be refunded to the employee losing out on the tax deduction. However, the excess contribution from the previous year will be reimbursed to the HCE as taxable income in the current year.

      Second, the employer can boost the minimum contribution rates of non-HCEs to meet the minimum rates by making non-elective employer contributions. The top-heavy test fail can be corrected through non-key employees receiving a contribution of up to 3% of compensation from the employer.

      The IRS 401k Plan Fix-it Guide offers more details on how to rectify ACP and ADP test failure.

      Ways to Minimize the Damage

      Employers can bypass the HCE rule by taking some steps:

      1. One solution is for the employee to continue making nondeductible contributions to the 401k plan. However, they will be trading off on accessing tax deductions.
      2. Another solution is to consider saving money in a taxable account. The employee will not have any limits to their retirement savings even if they are an HCE. They can manage their investment income as they see fit.
      3. There is also making catch-up contributions if the employee is 50 years or older. If the employee is 50 years or older, they can raise a $6,500 catch-up contribution in 2020 up to $26,000, and this amount extends to 2021.
      4. Opening a Health Savings Account (HSA) will allow employees to grow tax-deferred savings. This is useful as it will help cover their healthcare costs in the future. Participants save significantly on medical costs because they can withdraw money from an HSA without any tax deductions.

      How Does It Affect Your 401k Plan?

      Having an HCE in a 401k plan means foregoing some retirement savings and tax breaks. In addition, employers tend to fail the nondiscrimination test conducted every year largely due to its complexity.

      So, employers have to manage their 401k plans to ensure the contributions of HCEs do not exceed the contributions of non-HCEs by more than 2%.

      Failure to take action will lead to the plan no longer claiming tax-qualified status, and all contributions will have to be redistributed to the participants in the plan. In principle, HCEs might feel constrained in maximizing their retirement contributions.

      Why You Might Want To Consider a Safe Harbor 401k

      One downside of non-discriminating tests is locking out mostly small to medium-sized companies from passing them. When compared to larger businesses, they have a disproportionate number of HCEs compared to non-HCEs. So, with more HCEs on the payroll going through the test, it is challenging as the contributions of non-HCEs have to be higher.  

      A safe harbor 401k plan allows employers to find a way around the annual tests. With this plan, an employer is required to contribute to their employees’ retirement accounts in three ways.

      The first is the nonelective contribution of 3% made by the employer to every employee, including those not making contributions. The second way is to match 100% of the employees’ contributions on the first 3% of their compensation, and 50% on the next 2% of their compensation. The third option is for a company to match 100% of employees’ contributions with up to 4% of their compensation, but not exceeding a 6% limit.

      Integrating a safe harbor 401k means an HCE can max out their contributions, and employers do not have to deal with non-discriminating tests. It is important to note that the plan also has the same deferral limits as other 401ks, which are up to $19,500 per year for employees under 50 years, and a catch-up contribution limit of $26,000 for employees over age 50 or older.

      Conclusion

      Providing a 401k plan is a solid step towards ensuring a bright retirement future for your employees.

      Being a highly compensated employee as stipulated by the IRS can place a significant constraint on maxing out retirement savings. Fortunately, there are ways to counter this, such as opening an HSA account or taking advantage of the catch-up provision.

      For employers, they have the option of adopting a safe harbor 401k plan which is exempted from the complex non-discrimination tests and limit on contributions.

      The bottom line is, for any employer to have a highly motivated workforce, they need to effectively manage retirement plans for both highly compensated and non-highly compensated employees.

      If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.

      Should ESG Investments Be Included In A 401k?

      Should ESG Investments Be Included In A 401k?

      The topic of adding ESG investments inside of a 401k plans has been a popular topic as of late.

      On March 10, 2021, the U.S. Department of Labor announced its endorsement of two rules which had been on hold under the Trump administration. The first rule that will not be administered by EBSA is restricting investors from relying on Environmental, Social, and Governance (ESG) criteria to evaluate the majority of retirement investing that could potentially lock out some ESG investments. The second rule being put off is not allowing voting for ESG criteria.

      Despite the U.S. Government’s efforts to push ESG investing and more investors joining the bandwagon, it is slowly catching on mainly due to political and regulatory factors. From this outlook, the Biden administration is encouraging employers and employees to invest ESG funds in 401k plans.

      As a consequence, it is also prompting companies to care more about climate change and other issues to draw in more investors who care about such values. As retirement plans consider ESG funds, it is important to understand what they are all about.

      What Is an ESG Fund?

      It is a kind of portfolio constituting bonds and equities which incorporates environmental, social, and governance factors.

      For an organization or company to engage in ESG investing, they are evaluated by potential investors on environmental, social, and governance standards.  How does the company manage environmental issues such as conservation, animal testing, and the use of energy? Does the firm have a value system for how it relates to its stakeholders and the surrounding community? And, how does it deal with corporate governance issues, transparency, and accountability in their financial reporting, participation of stakeholders, and voting rights?

      Before an investor chooses to work with any company, they need to be assured of their values.

      ESG, however, is not a new phenomenon, as it caught on in the mid-2000s when it was highlighted during the 2006 United Nation’s Principles for Responsible Investment (PRI ) report. The idea was to use ESG as a metric for measuring the financial performance of firms to grow sustainable investments.

      How ESG Funds Work

      They apply both passive and active investing. Active ESG funds involve investors actively engaging companies to improve their ESG practices. They choose funds that fit their set criteria. As for passive ESG funds, companies rely on index providers such as MSCI. The indexes point out the companies with high-level ESG scores.

      Types of ESG Investments

      These are the leading options:

      1. Environmental ESG investments: These are available to firms promoting renewable energy resources.
      2. Social ESG investments: It is limited to companies that have a good reputation for upholding labor and human rights.
      3. Corporate governance ESG investments: Every investment is evaluated under corporate governance standards.

      Why Are They Becoming More Popular?

      According to the American Retirement Association, a survey revealed that 72 % of Americans were considering ESG funds. This means firms and organizations have to start streamlining their operations and culture to apply the growing trend of sustainability investing. A company is now more than a profit-making machine but one that creates a positive impact on its partners, employees, the environment, and the community.

      In 2020, there was an upsurge in ESG funds accounting for $51.1 billion from investors, double the previous year. Last year was a pivoting period for the whole of America dealing with significant social justice and environmental issues. In particular, investors were and are still keen on matters of climate change and racial and gender equality and put their money in institutions that applied ESG standards.

      Overall, two reasons sum up why ESG funds are being taken up by more investors:

      1. They promote common good 

      They focus on the commitment of a company to vital issues such as the environment and social justice. Companies are now rating themselves on how much they can impact communities by giving back. This draws in the majority of people, especially when matching values. Its main attractive quality is doing well while making profits.

      2. They generate large ROIs    

      ESG funds tend to perform well because the leadership performs according to its corporate governance rules, which safeguard the interest of investors. Even with the pandemic ravaging investments, ESG funds have outperformed most in the market.

        Is It a Good Idea to Add to Your Lineup?

        There has been a positive reception by employers towards the adoption of ESG options. However, the uptake is still very slow. But why is this? Before considering integrating ESG into a 401k plan, there are a few considerations.

        Similar to the management of 401k plans, ESG funds have regulations that make investors shy off. Previously, President Trump had set up rules preventing 401k plans from including ESG funds. So far, only 3% of plans offer ESG funds for investing, according to the Plan Sponsor Council of America. Even though the current government waylaid these rules, 401k fiduciaries want a stable legal foundation to include these funds.

        Another concern among employers is potential lawsuits by employees adding to the bag of other 401k lawsuits. Adding ESG options to the 401k plan will demand the plan advisors ensure the good performance of investments. Employers have to stay on top of effective asset allocation and diversification.

        On the other hand, ESG 401ks promise exponential performance for an organization. More and more investors want to link their portfolios to sustainable investing.  A good example of successful companies that have ESG funds in their retirement plans is Google Inc. and Amazon Inc. This is evident it can work. As more investors are getting into the trend, it is likely more employees will want to invest if these funds are included in their 401k plan. As time progresses, it may require more awareness and education of employees on ESG funds, which is initiated by the plan sponsors.

        Conclusion

        While there is a growing interest in channeling money into ESG funds, 401k plans are still lagging. It is expected for employers to be overly cautious about providing ESG fund options to employees due to the regulatory environment and risk of being sued.

        Even as advisors and administrators of the plan caution employers, more employees are showing interest in ESG 401k funds. Deciding if ESG funds are right for your company depends on how you can circumvent the barriers to their adoption, and if you can structure your 401k plan to adopt and set them up for success.

        If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.

        Employer Tax Benefits of a 401k

        Employer Tax Benefits of a 401k

        The 401k plan is among the most popular employer-sponsored retirement benefits plans in the United States. Data indicates that there were approximately 600,000 401k plans in 2020, with about 60 million active contributors.  In this article, we’ll discuss employer tax benefits of a 401k plan.

        While the majority of employees are eligible to participate in a 401k plan, many employers are still hesitant to offer it. According to a 2020 J.P. Morgan survey, less than 50% of employers offer a retirement savings plan. Out of those who do not offer an employer-sponsored retirement savings plan, 63% said that they had no future plans of offering a 401k match program. 

        Costs of a 401k

        The most cited factor that impedes employers from offering a 401k or any other employee-sponsored retirement savings plan is the perception of cost. Generally, there are three basic costs of a 401k, which include the start up costs, administration costs, and the matching costs. 

        The majority of the costs tend to be associated with the match.  However, many hesitate to even look into a 401k because of the perceived costs of the 401k.

        Some of these costs can be offset with tax breaks.

        employer tax benefits of a 401k

        Employer Tax Benefits of a 401k:  The SECURE Act

        Although sponsoring the 401k plan may seem too complex and cost-prohibitive for employers to consider, those who offer it clearly see the benefits, not just for their employees, but for their businesses as well. 

        Since the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in 2019, employers have more than one reason to jump on board with this highly valued benefit offering.

        In case you’re wondering what the SECURE Act is, it is a legislation that changes retirement plan design, administration, and compliance requirements. 

        Among the provisions to persuade employers to offer the 401k plan, the SECURE act guarantees several benefits, including:

        1. Tax Credits of Plan Startup Costs

        The SECURE Act makes setting up a 401k plan more affordable for employers, especially those running small businesses. Employers may be able to claim a tax credit up to $5,000 to cater for setting up the plan.  Employers are entitled to the tax credit for the first three years of the plan.

        To qualify for the retirement startup costs tax credit, a small business must have 100 or fewer employees who receive at least $5,000 in compensation in the previous year. The small business must also have at least one 401k plan participant who’s not a non-highly compensated employee. 

        2. Tax Credits of Administration Costs

        After setting up a 401k plan, an employer incurs administrative costs of maintaining the plan. The day-to-day operation of a 401k plan involves costs for basic and essential administrative services, like plan recordkeeping, accounting, trustee, and legal services. 

        With the SECURE Act in place, small business employers who meet eligibility requirements can claim tax credits of administrative costs. The tax credit is available to cover 50% of the administrative costs of implementing the 401k plan.

          3. Tax Benefits of Contributions

          One of the frequently asked questions about retirement plans is: are 401k contributions tax deductible for employer? The answer is yes. Since 401k plan contributions reduce an employer’s taxable income, employers can deduct contributions on the company’s federal income tax return to the point that the contributions don’t go beyond certain limitations. 

          The taxes for the year should be reduced by the contribution amount multiplied by the marginal tax rate, as per the employer’s tax bracket. The more income, and thus the tax bracket, the more the tax savings from contributing to the 401k plan. 

          4. Tax Credits of Establishing Automatic Enrollment Plans

          In addition to the tax credit for startup costs, the SECURE Act proposed a new tax credit known as the Small Employer Automatic Enrollment Tax Credit. Eligible employers that add an automatic-enrollment feature to their retirement plan can claim a tax credit of $500 per year for a three-year taxable period, starting with the first taxable year the employer adds the auto-enrollment feature. 

          Like other tax credits, the Small Employer Automatic Enrollment Tax Credit is pretty much for small businesses for a very small action. The automatic enrolment tax credit is also available to small business employers that convert an existing retirement plan to an automatic enrollment design.

           

          employer tax benefits of a 401k

          mployer Non-Tax Benefits of a 401k

          In addition to the above tax benefits of a 401k, employers get to enjoy other benefits. For instance, offering a 401k helps with employee acquisition, boosts employee satisfaction and increases employee retention.

          According to research by PR Newswire, four in five employees prefer new or additional employee benefits or perks to more money in their pay check, citing that benefits provide better experiences and increase satisfaction. Defined contribution plans, such as the 401k are ranked among the top benefits that employees would prefer over a pay rise.  

          Get Professional Help in Implementing 401k Employer Tax Benefits 

          The overall goal of the SECURE Act is to simplify the 401k implementation process and offer benefits to employees. Nevertheless, it doesn’t necessarily mean that employers should try to tackle setting up a 401k plan without some form of guidance.

          Would you like to enjoy the employer tax benefits of a 401k plan but don’t know where to start? 

          Life, Inc. Retirement Services can help. We are a 401k provider dedicated to simplifying the 401k implementation process to make it as seamless and easy for employers. 

          Whether you’re a startup, solo entrepreneur, corporation, or financial advisor, we will offer a customized solution that is right for your business.

           

          If you need help finding which plan makes sense for your company, schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with The Retirement Plan Evaluator.