Challenges of Setting Up Basic 401(k) Plans for Small Businesses
Small businesses strive to offer their employees competitive benefits, including a strong retirement plan with low fees and good investment options. The most common form of a retirement plan for a small business is a traditional 401(k) plan because it provides the most flexibility. Before you decide to offer a 401(k) plan, be sure you have the resources in place to properly set up and operate it. Neglecting this preparation can be costly and time consuming to correct.
Setting up the basic plan
One of the biggest decisions you will make early on is with whom you will work to you set up and operate the plan. To assist you with this process, you may seek advice from your CPA, an advisor, or the Employee Retirement Income Security Act (ERISA) Advisory Council.
Since the assets in the plan need to be used solely for participants and their beneficiaries, they need to be maintained in a trust. Selecting a trustee or an insurance company will be your first decision. The next decision will be choosing a company to maintain the records, which will include tracking contributions, earnings, and distributions. Finally, you will need to develop a written plan document which provides the foundation and day-to-day details of the plan’s operation.
Plan monitoring and management
After the plan is set up, you should continue to monitor the operation of the plan to ensure that it is working as outlined in the plan document. Some of the most common errors are not following the plan’s definitions of eligibility and compensation, or making delinquent contributions to participant accounts. Most plans still have an age and service requirement for participation, which needs to be monitored to ensure that when an individual meets the requirements, they are offered the opportunity to enter the plan. Plan management has some flexibility in the way it defines the term “compensation” in the plan document, but contributions that are calculated and remitted using an incorrect definition of compensation will require correction.
Late contributions are one of the most common plan management errors. For plans with fewer than 100 participants, salary reduction contributions must be deposited with the plan no later than the seventh business day following withholding by the employer. If you are late, these contributions should be reported as delinquent on the Form 5500 and lost earnings must be remitted to the plan.
Another common challenge with small plans is passing the nondiscrimination testing. To preserve the tax benefits of a 401(k) plan, the plan must provide substantive benefits for rank-and-file employees (non-highly compensated employees), not just business owners and managers (highly compensated employees). Nondiscrimination tests compare both plan participation and contributions of rank-and-file employees to those of owners and managers.
Plan sponsors must test traditional 401(k) plans each year to ensure that the contributions made by and for rank-and-file employees are proportional to contributions made for owners and managers. If your plan fails the non-discrimination test, you must take corrective action and either provide an additional contribution to all non-highly compensated employees or distribute excess contributions from highly compensated employees. Adjusting your plan design can either eliminate the need for the testing or help you pass the yearly test.
Finally, even though you may be a small plan, you are still subject to all of the fiduciary compliance rules for ERISA retirement plans. One of your most important decisions is selecting your fiduciaries. Fiduciary responsibilities include the following:
- Acting solely in the interest of the participants and their beneficiaries
- Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan
- Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters
- Following the plan documents
- Diversifying plan investments
It is important to note that fiduciary responsibilities cover the overall plan process rather than just end results, so the rationale behind any decision must be documented in order to limit liability. Another way to limit your liability is to hire a service provider to assume some of the fiduciary responsibilities, as well as some of the liability.
How we can help
CliftonLarsonAllen understands the benefits of a plan that is operated well, with clear fiduciary roles, and all compliance obligations met. Our employee benefit group helps plan sponsors of all sizes stay in compliance with all aspects of the ERISA and the Internal Revenue Code, while guiding them to take proactive measures related to new regulations.