2022 – An Ideal Time to Review Plan Design
Each year, those in the retirement community collect, analyze and calculate data to ensure plan compliance with the laws that govern qualified retirement plans. The calendar of deadlines repeats each year, challenging plan sponsors and service providers to focus on the current plan compliance along with the myriad of changes that have come into effect in the last few years. In addition, the COVID-19 pandemic created many financial difficulties and workplace changes for millions of employees and business owners. So, keeping abreast of the ‘normal' routine of retirement planning, compliance has become anything but ‘normal.'
The restatement period provides employers with an opportunity to enhance their existing retirement plans — especially if demographics, operations or hiring strategies at the company have changed. The timing of Cycle 3 means that recent changes, such as the hardship distribution regulations effective in January 2019, the SECURE Act of 2019, and the CARES Act of 2020, will need to be addressed in separate, good-faith amendments and will not be included in this restatement period. Cycle 3 restatements will, however, include language pertaining to regulatory changes enacted prior to February 1, 2017. These changes include:
- Expansion of the definition of "spouse" to include those of the same gender;
- Availability of plan forfeitures to offset additional types of company contributions;
- Ability to amend safe harbor 401(k) plans once the year has already started;
- Creation of in-plan Roth transfers.
Plan document restatement cycles give employers and service providers an opportunity to look at the retirement plan as a whole and evaluate the effects that law changes have on the effectiveness of the overall design and goals for the plan and its participants. For many employers and employees, COVID-19 had a detrimental impact on the ability to contribute to the plan. Additionally, many individuals found themselves withdrawing funds from their retirement savings, creating a downturn that will be challenging to recover from. So, a restatement, while mandatory, gives the employer an opportunity to implement solutions that can help individuals get back on track. Some plan design options to consider are listed below:
Eligibility: Eligibility defines how and when employees can join your retirement plan. Though your current eligibility requirements may fit the company's employee demographic for full-time employees, the SECURE Act permits long term part-time employees (LTPTs) the ability to enter the plan starting in 2024, provided that they have satisfied the legally mandated requirements. Though SECURE Act law will not be included in this restatement, it seems wise to explore the effects that LTPT employees may have on your plan's design and filing requirements.
Implement or expand auto-enrollment: Auto-enrollment enables employers to automatically enroll new hires into the retirement plan. Employees can always opt out of auto-enrollment if they decide they do not want to participate in the plan. Auto-enrollment has proven to be a successful tool in expanding retirement plan usage, especially among younger employees. According to a Principal Retirement Security Survey in July 2021, 84% of workers that were automatically enrolled in their workplace retirement plan say they started to save for retirement earlier than if they had to take action to make the enrollment decision on their own. To further help maximize savings and improve outcomes, employers may want to consider enrolling new employees at a higher deferral rate, such as 6%, rather than the standard 3%. The 6% rate will be far more meaningful for retirement and, though there is a risk that more participants could opt-out of the plan, a 2020 report released by John Hancock states the opposite to be true.
Under the SECURE Act, an eligible employer that adds an auto-enrollment feature to their plan can claim a tax credit of $500 per year for a three-year taxable period beginning with the first taxable year the employer includes the auto-enrollment feature.
Increase re-enrollment adoption: Re-enrollment has become increasingly important due to the effects of the COVID-19 pandemic. In a white paper for Voya Financial, Shlomo Benartzi, professor emeritus at UCLA Anderson School of Management, suggested frequently re-enrolling existing participants. He pointed to the U.K., where plan providers are required to automatically re-enroll workers every three years, even if they've previously opted out. Principal's study group stated that they were glad their savings had been "jump-started" and reinforced that, if left to make the decision on their own, many wouldn't have joined or would have at least delayed their enrollment.
Implement or expand auto-escalation: With auto-escalation, employees' contributions are automatically increased every year. For example, employers can increase deferral rates by 1% each year up to a maximum of 15% of pay.
Redesign matching contributions. The pandemic has pressured many employers to discontinue or reduce their 401(k) contribution matches. Rebooting the matching contributions will go a long way in revitalizing employee interest in your plan. If the previous formula does not fit economically, employers might consider reducing the overall matching percentage but increase the cap on contributions (Example: 50% match up to 4% of pay changed to 25% up to 8%). This approach encourages the participant to defer a higher percentage of pay to receive the full matching contribution.
Dr. Benartzi suggested considering a fixed amount matching formula. From the participant's perspective, a dollar amount seems more real than applying percentages to one's paycheck. "Psychologically, it's easy to give up a 6% match, but it's hard to let go of a $1,200 lump sum," he wrote.
The pandemic presented unprecedented challenges for employers that offer retirement plan benefits. With the future looking brighter and the Cycle 3 restatement deadline around the corner, now is the optimal time for business owners to review, and if necessary, update their plan design to align with the company's goals and changing employee demographics.
- SECURE Act Provisions for Long-Term Part-Time Employees
Historically, 401(k) plans could exclude individuals who worked less than 1,000 hours in the plan year. However, in its effort to expand access to employer retirement plans, the Setting Every Community Up for Retirement Enhancement (SECURE) Act introduced the concept of a "long-term, part-time employee" (LTPT). The Act requires that starting in 2024, 401(k) plans permit LTPTs the opportunity to elect to make salary deferrals to a 401(k) plan.
So, why talk about it now if not effective until 2024? The definition of an LTPT employee is as follows:
- An employee who has completed three consecutive 12-month periods with at least 500 hours of service during each of those periods, and
- Who has reached the age of 21 by the end of the three-year period.
Eligibility - Since eligibility will be determined based upon hours worked in 2021, 2022 and 2023, plan sponsors and service providers must accurately track and report hours for LTPT employees. LTPT employees who meet these requirements must be allowed to contribute salary deferrals to the plan. However, they may be excluded from employer contributions and nondiscrimination testing. Employees covered by a collective bargaining agreement are not covered by the LTPT rules.
The law pertaining to LTPT employees may create dual eligibility requirements under the plan, assuming that the plan's existing eligibility requirements are not as favorable as those required for LTPT employees. Plan sponsors and their service providers must monitor both the existing service requirement and the eligibility requirements applicable to LTPT employees.
Employer Contributions - LTPT employees may be excluded from employer matching and profit-sharing contributions, as well as safe harbor contributions under a safe harbor 401(k) plan. However, if an LTPT employee satisfies the general minimum age and service requirements by completing at least 1,000 hours of service, they become eligible to participate in employer contributions.
Vesting - In retirement plans, employees, LTPT or otherwise, are always 100% vested in their salary deferral accounts. So, the subject of vesting only applies if an employer voluntarily elects to include LTPT employees in their company contributions that are subject to a vesting schedule. LTPT years of service for vesting purposes must include each 12-month period during which the employee has 500 hours of service or more for all years, including 12-month periods before January 1, 2021.
The main objective of the LTPT rules was to expand retirement coverage to a greater number of working Americans. However, the rules can have significant effects on plans designed under prior law. The possible entry of previously excluded employees and the maintenance of dual eligibility requirements can put an extra burden on plan sponsors and service providers. Considering this new requirement, reviewing the plan's design is an important "to-do" for 2022.
- Navigating the Labyrinth of Required Minimum Distributions
- One more twist…
- Upcoming Compliance Deadlines for Calendar-Year Plans
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.