Key Considerations for Retirement Plan Design
by Mike Rahn, CISP
The approaching end of a retirement plan year is an excellent time to evaluate whether current plan provisions still fit the employer’s situation and objectives. Provisions that made sense when the plan was established may have become outdated with changes in the workforce, the industry, or the employer’s goal. It may be time to amend for plan design changes.
In evaluating plan design features, a plan administrator should consider many factors. Here are some important ones.
Number of employees; number of full-time vs. part-time employees; number of temporary employees if any, etc.
Economic changes that have affected the employer’s business or industry
Administrative burden/compliance expenses
Changes in related employer relationships, including common ownership or purpose, or service affiliations
Legislative or guidance changes that have affected plan features
Changes in employer saving or benefit objectives
Perhaps when the plan was established, the employer merely wanted to offer the opportunity for employees to save for their own retirement. As time passes and the company grows, is that still the objective? Does the employer wish to do more to encourage more employees to contribute?
Common Plan Design Changes
U.S. laws and regulations make available many different features for retirement plans. The following plan features should be evaluated when considering plan design changes.
Eligibility service requirements can be lengthened or shortened without violating protected benefit rules. Entry date frequency, eligibility age requirements, service crediting methods, and eligibility class exclusions can also be changed, but only on a prospective basis.
Employer Contribution Allocation Conditions
Some plans require conditions beyond basic eligibility in order to receive an employer contribution in any given plan year. Allocation conditions, like a last-day or hours-of-service requirement, can be added or changed, but are best made as of the beginning of a plan year to avoid any potential elimination of a protected benefit.
Employee Contribution Changes
An employer may consider changing certain employee contribution features.
Adding a 401(k) employee deferral element to a profit sharing-only plan may be an option.
Adding a Roth deferral component would allow employees to make Roth after-tax contributions, the proceeds of which—including earnings—can be tax-free.
Adding an automatic enrollment feature may increase participation, help ensure that employees are not only saving more, but are more financially prepared for retirement, and possibly improve compliance-testing results, allowing highly-compensated employees (HCEs) to contribute more. Special employee notifications are required.
Employer Contribution Changes
An employer may wish to add, reduce, or eliminate an employer contribution feature within the plan.
Profit sharing contributions go to all eligible employees, regardless of whether they make deferral contributions. This can be either fixed (required) or discretionary for any given year. Employers with this feature sometimes amend to a different formula (e.g., new comparability) to allow greater flexibility in how contributions are allocated among participants.
Matching contributions go to eligible employees who make deferral contributions, with the employer typically matching all or some of an employee’s contribution. This too can be fixed or discretionary. A fixed match may encourage some participants to defer at rates higher than they otherwise would.
Though annual compliance testing is required for qualified retirement plans, some limited changes can be made that may work to the employer’s advantage.
The actual deferral percentage/actual contribution percentage (ADP/ACP) nondiscrimination testing method can be changed from “prior-year” to “current-year” at any time, or the reverse under certain circumstances. The prior-year method allows an employer to know in advance the maximum deferral rate for HCEs that will pass ADP/ACP testing.
The top-paid group election can also affect testing results. The employer can limit the number of HCEs to only the top 20 percent of all employees, ranked by compensation. This may increase the number of employees in the nonHCE testing group, potentially improving testing results and allowing larger contributions for HCEs.
Adding an ADP/ACP safe harbor feature requires a modest employer contribution, 100 percent vested, but allows HCEs to contribute at maximum deferral rates. Typically the top-heavy test would also be deemed satisfied.
Another consideration is to change the plan’s vesting schedule, which dictates how quickly employer contributions become fully nonforfeitable. A longer vesting schedule can encourage the retention of employees. Specific rules pertain to how vesting will apply to existing and future contributions.
Changes to the vesting schedule often bring additional administrative duty. Due to the risk of applying complicated vesting rules incorrectly, employers should carefully think through any vesting schedule amendments.
Distribution Triggering Events
The plan document defines the distribution triggering events. Typically, distributions are allowed upon termination from employment and upon reaching the plan’s normal retirement age. In addition, certain distributions—often referred to as “in-service” distributions—may be allowed while the participant is still working. Elective deferrals generally are not available before age 59½ if still employed, but employer contributions may be available earlier.
The right to take an in-service distribution generally is a protected benefit. Thus, if the employer decides to amend the plan to remove an in-service option, the employer must be prepared to track the accrued benefits before the amendment’s effective date. These benefits must continue to be available upon the in-service event, even though this option will not be available for assets accrued after the amendment takes effect.