Small to mid-size professional service firms are currently scrambling to re-adjust their budgets due to the economic disruption of coronavirus restrictions. As a result, 401(k) providers such as myself have been fielding many questions recently from plan sponsors who are asking whether safe harbor contributions may be suspended and what other considerations should be considered prior to moving forward.
Unlike many other aspects of the rules governing qualified plans such as 401(k), the answer to the first question is fairly simple. The IRS does allow plan sponsors to amend their plan documents mid-year to suspend a company’s safe harbor contributions. But there are some caveats as listed below. This would be true whether your plan uses the safe harbor non-elective or one of several qualifying safe harbor matching formulas.
That is the easy part. The considerations that must factored prior to making this decision are more complex. My objective here is to clearly lay out these issues as they apply to safe harbor plans in general. My objective here is to give you an aerial view of the factors that come in to play for mostplans. Because the details of your plan document are critical, plan sponsors should consult with your TPA and other plan providers prior to moving forward.
Removing Safe Harbor
In order to suspend employer contributions, plan sponsors must first amend the plan document to remove the safe harbor provision. The rules require that a supplemental notice be given to all eligible employees not less than 30 days prior to the change.
There are a few contingencies, however, that must be considered:
Participants must be allowed to change their deferrals prior to the change becoming effective.
The employer must have included in the annual safe harbor notice a statement that the plan could be amended mid-year to reduce or suspend safe harbor contributions – or –provide evidence that they would be operating at an economic loss. Employers and related employers in the same controlled group would need to show that expenses exceed income for the year based on generally accepted accounting principles.
The suspension cannot be effective for at least 30 days after the later of the supplemental notice or the effective date of the plan amendment.
An employer who suspends or reduces its safe harbor mid-year must pay the safe harbor contribution amount from the beginning of the plan year up to the effective date of the change. The annual compensation limit used to calculate the safe harbor contribution would be pro-rated up to the date of suspension.
There are, however, some really, really important caveats that must be considered to avoid some unintended consequences for employers.
Year to Date Contributions
Employers who suspend contributions mid-plan year are not relieved of the duty to fund safe harbor contributions for the period from the beginning of the plan year through the date the safe harbor suspension becomes effective. For example, if an employer provides notice on May 1, 2020, the safe harbor contribution will be calculated on eligible wages and deferrals through May 30, 2020.
But for businesses who expect cash flow to return to pre-virus levels, there is some good news. Employers are able to minimize the impact of required contributions by postponing deposit deadlines. In order for your contribution to be tax deductible, the deposit must be made by the due date, with extensions, of your company’s tax return. For a company operating on a calendar tax year ending December 31, 2020,the deposit deadline could be as late as October of 2021. If you are not concerned about claiming the tax deduction, you would have up until December 31, 2121 to deposit the 2020 contributions.
If your plan calculates your contributions on some period other than a full year, e.g. per pay period or per quarter, the deposit deadline is accelerated to the end of the quarter following the quarter in which the match accrues. That means contributions accrued through June 30, 2020 would have to be deposited no later than September 30, 2020.
One final caveat should be considered for extending contribution deadlines. If your plan specifies that the match is to be based on annual compensation and deferrals but operationally chooses to make deposits each pay period, it would qualify as an annual match subject to the former extended deposit deadlines.
If you currently have a pay period match, you can amend your document to provide for an annual match in order to have more time to make the required deposits. Keep in mind this change must be retroactive to the beginning of your plan year. This may result in true-up amounts for any participant who may have front loaded their deferrals. This can be tricky, so make sure you review your plan documents and year to date deferrals with your TPA.
Loss of Top-Heavy Exemption
It is important to realize that a plan that elects to suspend safe harbor is now subject to top heavy rules. In order to avoid punitive top heavy provisions, the aggregate value of the assets of key employees must not exceed 60% of the total assets of the plan. If key employees have been contributing during the year, this could result in a required contribution equal to 3% of wages for all non-key employees. On the other hand, if no key employees have deferred into the plan or received employer contributions year to date, the minimum required contribution is zero.
Since the goal for most employers who wish to suspend safe harbor contributions is to reduce employer costs, a review of year-to-date contributions and a plan’s top heavy status is a crucial step in the decision making process. You may find that suspending contributions would be significantly offset by these addition payments to all eligible, non-key employees. You might be better off canceling your free gym memberships!
However, employers who are required to make these top heavy contributions would have until their tax filing date or extension (e.g. April 15 or October 15, 2020) to make a deposit in order to claim the contributions as a tax deduction, or by December 31, 2020to simply comply.
ADP/ACP Testing
Plan sponsors who elect to suspend safe harbor provisions mid-year will additionally be subject to ADP/ACP non-discrimination testing. Depending on how early in the year the suspension becomes effective, plans should have more flexibility to avoid corrective distributions by limiting or controlling the deferrals made by highly compensated employees from that point thru year end. Corrective refunds, should they be necessary, create additional administrative costs and complexity for plans and should be factored in to this decision.
Reinstatement of Safe Harbor Provisions
For plans with safe harbor provisions based on tiered or match formulas, the current rules do not allow plan sponsors to reinstate to be effective within the same plan year . However, these matching options can be amended not less than 30 days prior to year-end to be effective January 1 of following plan year.
However, the passage of the SECURE Act has given employers additional flexibility to reinstate non-elective safe harbor provisions during the current plan year. It is even possible under provisions of the bill to establish non-elective safe harbor provisions to the plan after year end.
That means plan sponsors are allowed amend their plan documents to remove safe harbor provisions now and should their financial situation improve, amend again to retroactively add back the safe harbor provision for 2020 provided they do so by December 3, 2021.
Unchartered Territory
Let’s face it.Plan sponsors and their providers are navigating uncharted territory with current economic uncertainty and regulatory changes. I have attempted to outline some of the general considerations and consequences of a decision to suspend safe harbor contributions.
Although not a prediction, it would not be surprising to see future rule changes that may impact these decisions. Plan sponsors should be advised to consult your TPA and ERISA attorney for specific guidance based on your current situation and further consider the potential costs and contingencies that would result from a potential suspension of safe harbor contributions.
Brian C. Rall
President-Strategic Retirement Partners, LLC
April 29, 2020
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
A recent article published in the Wall Street Journal, “Retirement Bills in Congress Could Alter 401(k) Plans”, reviewed a number of proposed changes to existing retirement and savings plans being considered in Congress. The following proposals are currently working through a bi-partisan Senate bill known as the Retirement Enhancement and Savings Act, or RESA, sponsored by Senate Finance Committee chairman, Orrin Hatch (R., Utah) and its top Democrat, Ron Wyden of Oregon.
Among the various proposals for change in 401(k) plans are the following:
Allowing small employers to join multiple-employer plans, or MEP’s, regardless of affiliation with an industry trade association as is now required.
Incentives to 401(k) plan sponsors to offer annuities which would allow participants to transform their balances into lifetime monthly income streams. Plan sponsors must disclose the monthly annuity income their savings would support and would be protected from future lawsuits when selecting an annuity provider.
Further incentives for employers (not specified in the article) to adopt automatic enrollment provisions to their plans.
An expansion of the tax credit currently available to small companies to offset the costs of starting a new 401(k) plan.
The article explains that while there is broad interest by both sides of the aisle in encouraging saving and retirement, the good news appears to be that it isn’t clear which, if any, of these measures would likely survive the legislative process.
Forgive my skepticism, but this promise by Congress to help us all save more in our retirement accounts should be regarded with the same cynical response as when we hear the following statements:
“The check is in the mail.”
“You look good in a cowboy hat!”
“I’m from the government and I’m here to help you!”
Is this really what the Washington “experts” call a comprehensive solution to the savings crisis in America? As John McEnroe so eloquently stated, “You have got to be kidding me!”
Multiple Employer Plans Are Not the Answer!
Just to bring everyone reading this up to speed, a multiple-employer 401(k), or MEP, is a 401(k) plan that is co-sponsored by two or more unrelated employers. Trade associations have offered “closed” MEPs to members for decades. Recently, some 401(k) providers have begun offering “open” MEPs which any employer can join. Regardless of type, MEP’s require more complex annual administration because they have the potential to co-mingle the assets of hundreds of employers. While MEP providers promote these plans as having lower fees due to “economies of scale” while reducing the 401(k) fiduciary liabilities to employer co-sponsors, in truth, MEP’s offer neither.
The claim that MEP’s offer lower fees and higher quality services “may have been true 10+ years ago in an environment of hidden fees…and rewarded plans with lots of assets. However, that’s not the case today.” He observes that even start-up plans with no assets can access low-cost institutional investments and advice and that “technology has made 401(k) administration services cheaper than ever to deliver, allowing 401(k) providers to charge low flat fees.”
Employer co-sponsors still retain the difficult (if not impossible) fiduciary responsibility to monitor all 401(k) providers given discretionary control or administration of plan assets. Droblyen argues that this oversight is beyond the scope of most, if not all, employers and “ironically, actually increases an employer’s fiduciary responsibility”.
“Good luck getting out of an MEP”, writes Droblyen. Unlike single employer 401(k) plans, employers who are part of an MEP lack the authority to terminate their portion of the plan. This creates big problems, he believes. “Employee accounts can be stuck in a MEP until they terminate employment or become eligible for an in-service distribution.”
Just try rolling that news out to angry employees who want to re-locate their retirement balances into an IRA!
401(k) Annuity Options Benefit Insurance Companies – Not Most Retirees.
Let’s begin with the two main advantages of owning an annuity. Most annuity options within 401(k) plans today are variable annuity products with what is termed a “Guaranteed Lifetime Withdrawal Benefit” rider. Because insurance companies typically guarantee the benefit base, these products do offer a “back-stop” against down markets, especially near retirement age. There is also a form of longevity insurance in that once annuitized, the payments are guaranteed for life.
However, these intended benefits usually come with high embedded fees and perhaps more significantly for younger savers, the opportunity costs of investing in traditional securities that generate significantly higher long-term returns.
“Any insurance product is going to have a negative expected value”, says Daniel Farkas, a senior investment consultant with Morningstar Investment Management. Farkas adds, “I mean that on average, you are going to have been better off if you didn’t buy the insurance; that’s the case for these products”.
Inherent in the logic of this bill is that employees to analyze and compare these instruments against other alternatives in order to evaluate whether they make sense for their situation. And that’s the problem: in most cases, they can’t. It’s critical that plans that offer complex financial instruments such as GLWB riders have access to an investment advisor who can help them make good decisions with these products. If you are not getting this kind of service with your current advisor, Strategic Retirement Partners can help.
The argument I’m making here is not that all insurance products are bad, but that the annuity initiatives included in these proposals will ultimately be directed at a demographic that can neither define what an annuity is or how it will likely work for their own retirement situation. An overwhelming majority of employees do not have the knowledge or understanding of financial instruments to properly evaluate whether a variable annuity is right for them. And they have even less capability to evaluate and monitor the financial risk inherent to the insurance company backing these legal promises. That sounds like trouble to me.
If I Lose My Investment, I Can’t Sue You!
The proposal to limit the fiduciary liability to employers who include a variable annuity option in their 401(k) is shockingly self-serving and reveals the true beneficiaries of this proposal – the insurance companies who offer these products and their quid pro quo with lawmakers who seek future campaign contributions. To lower the fiduciary liability for certain financial instruments simply to enrich insurance company profits is misguided policy at best, dangerous for savers, and bad for our industry.
Auto–Enrollment Is Not Broken, So Don’t Try to Fix It!
Auto enrollment today is one of the fastest growing 401(k) plan features. In addition to the fact that plans adopting this feature have significantly higher participation rates, employers have been incentivized by greater flexibility with eligibility and vesting options and lower safe harbor matching requirements. Currently, eligible employees may already opt out or change their deferral percentages without penalty. That’s the trouble with government: fixing things that are not broken and not fixing things that are broken.
Auto-enrollment has had a tremendous impact on plan participation since it was introduced in 2006. But like most plan features, it is not right for every plan. At Strategic Retirement Partners, we will help you determine if an auto enrollment feature belongs in your plan.
Increasing the Tax Credit Will Increase the Number of 401(k) Plans.
One of the biggest hurdles for small employers in their decision to establish these plans is the up-front administrative costs to create and file the plan documents and employee communications. While the current tax credit– 50% of administrative expenses over the first three years of establishing a plan, up to $1,500 – is critically important in offsetting a portion of this cost to employers, increasing the amount of this credit or accelerating the time period in which it can be applied would be the single most effective measure in this proposed legislation. Enhancing the tax credit for employers with fewer than 100 employees will significantly increase the number of 401(k) plans and is smart policy.
You Look Good in a Cowboy Hat!
In summary, the proposals under consideration by RESA, with exception of an increase in the tax credit for new plans, appear to be weak at best. And in the case of incentives for obsolete MEPs and complex variable annuities, they are potentially damaging to the savers it seeks to help.
If you say the check is in the mail, I’ll believe it when I see it.
If you think you look good in a cowboy hat, God bless you!
But if you say you are with the government and you are here to help me, I think I’ll take a pass on that one!
Brian C. Rall
President – Strategic Retirement Partners, LLC
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
It is highly probable that your company’s 401(k) plan will be subjected to audits conducted by the DOL and the Internal Revenue Service at some point in the future. If you are not 100% certain what documents you will need, download this free copy of our “Fiduciary Audit File Checklist” and be sure!
