401(k) Basics
An Intro to the 401(k)
A 401(k) is a retirement plan that deducts employee contributions directly from their payroll to their retirement account. Often the 401(k) will include both traditional and Roth options. People often need clarification on the differences between IRAs and 401(k) plans. Some characteristics make 401(k)s a unique and powerful employee benefit. However, 401(k)s are not for every company. Like so many other aspects of life- added flexibility brings with it added costs, responsibilities, and complexities. A good team of professionals can help you simplify things.
401(k) Service Providers
You can break up a 401(k) into 3-pieces: TPA, recordkeeper, and advisor.
Third-Party Administrator (TPA)
Some of the TPA's duties can include the following:
Plan compliance testing
Help with plan design
Creating and updating plan documents
Helping prepare IRS forms
Staying up to date with changes in 401(k) law
It's important to remember that 401(k) plans have governing documents called plan documents. Though there are many options and flexibility in a 401(k) plan, you must first make amendments to the plan documents before proceeding with a change in plan design.
Recordkeeper
Some of the recordkeeper's duties can include the following:
Accounting of the plan and its participants
Maintaining the 401(k) website
Tracking and investing contributions for participants
Storing participant investment elections.
The recordkeeper is the most easily recognized by the employer and plan participants since participants log in to the recordkeeper's website to make account changes. Sometimes the recordkeeper and TPA will be the same company; these structures are "bundled" plans.
Plan Advisor
Not all plans have a financial advisor, but having one can be very beneficial. Here are some of the responsibilities an advisor can have.
Recommend and monitor investments
Provide plan reviews
Help with plan compliance
Offer participant education
Offer fiduciary service
There are a lot of advisors out there. Some focus on 401(k) plans, but many focus on personal financial planning. You should find an advisor that has experience with 401(k) plans.
Taxes
Employee Contribution Maximums
$22,500 or $30,000 for those over 50 years old for 2023. The employee contribution and match cap is $66,000, or 100% of employee compensation. For those over 50, the limit is $73,500. The maximum contribution limits change almost yearly to account for inflation. Once again, these numbers are for 2023.
Plan Design
Contributions and Benefits Must Not Discriminate
The plan cannot discriminate in favor of highly compensated employees. Because of this, there are multiple tests that a TPA (third-party administrator) runs to ensure the plan is not discriminating in favor of the highly compensated.
Eligibility
Generally, employees must be allowed to participate if they meet two of the following.
Reach age 21
Complete 1-year of service
Employers can be less restrictive if they want.
Matching
401(k) plans only have to offer a match if it is a Safe-Harbor plan. There is a lot of flexibility in how it can be structured. Once again, it's important to stress that the plan documents dictate this.
Vesting
A participant's contributions to a retirement plan are always theirs to take with them if they leave employment. Vesting schedules are an option for a 401(k) plan on the company contributions. Some plan structures require 100% vesting. Here are two common types of vesting
Cliff vesting: the employer contributions vest 100% at a specific time of service.
Graded vesting: a percentage of the employer contribution is vested annually until a certain amount of years of service.
Does a 401(k) Make Sense for Your Company?
If you are looking for specific structures, eligibility rules, design flexibility, and vesting, a 401(k) might make sense for your company.
Pros
A variety of investment options
Vesting schedules options for employer contributions
Flexible eligibility rules (more so than some other plans)
Higher contribution limits
Several matching options
Traditional and Roth options are available
Contributions are tax-deductible
Cons
Generally, higher admin costs
Added administration duties
Filing requirements
Plan testing
Plan audits (for larger companies)
Talk to a professional to ensure you understand all your options; don't hesitate to contact us. Also, if you are looking for guidance in choosing a retirement plan, we would love to help.