A well-executed 401(k) plan can be a valuable tool for recruiting and retaining talented employees. But small business owners should also understand their legal obligations if they decide to offer 401(k)s.
The Employee Retirement Income Security Act (ERISA) requires employers to meet certain requirements as 401(k) plan providers. Ignoring or neglecting the rules can lead to a plan being disqualified ”“ as well as fines and unhappy employees.
What are some of the most common areas that employers run into trouble?
Fees ”“ The law requires plan fees to be “reasonable.” Though there is no specified level for reasonable fees, it makes sense to compare estimates from different providers when selecting a plan and to track fee levels over time. Compare the level of service provided with the cost. Small employers are often stuck with higher fees because they don”™t have the leverage to negotiate effectively, but that doesn”™t mean you can”™t shop around for a better deal. Additionally, the plan document must be clear about who pays the fees (the plan, the employer or both).
Fund Offerings ”“ Plan sponsors have a responsibility to ensure the plan offers an appropriately diverse menu of funds, and that the plan”™s default option is a reasonable choice for the average participant. The default percentage withdrawn from paychecks should neither be too large nor unrealistically small.
Eligible Employees ”“ All eligible employees must be notified of certain benefits, rights and features. You cannot exclude employees from the plan without cause. Typically, only employees under 21 or who have worked for the company less than a year may be excluded. (Some other exclusions are permitted, but take care they are legal.) If your plan does not include automatic enrollment, make sure that employee notifications are documented.
Participant Information ”“ All participants must receive a summary plan description, which details how the 401(k) plan operates. If the plan allows participants to direct their own investments, the plan sponsor or the sponsor”™s agent must also provide fee and expense information about investments in the plan.
Highly Compensated Employees ”“ Employees making more than $115,000 per year, as well as the business owner and his or her immediately family, must be compared as a group to all other employees. The highly compensated employees (HCEs) cannot defer an average of more than 2 percent over what the non-HCE group defers. Additionally, the owners and his or her immediate family, plus any corporate officers earning more than $165,000, must collectively hold less than 60 percent of the plan”™s total value.
Matching Contributions ”“ Annually, employers cannot contribute more than the lesser of 100 percent of an employee”™s compensation or a set maximum amount for combined employee and employer contributions ($51,000 in 2013).
Vesting ”“ While employee contributions are automatically 100 percent vested, you can choose whether employer contributions vest over time, according to a vesting schedule. If you do so, make sure the vesting schedule is explicit and clear to participants. (However, in a safe harbor 401(k) plan, employer contributions must vest completely and immediately.)
Prompt Deposits ”“ For plans with fewer than 100 participants, contributions withdrawn from a participant”™s salary must be deposited with the plan no later than the seventh business day following withholding. The plan must designate a fiduciary (typically the trustee) to ensure withholdings and employer matching contributions, if any, are successfully transmitted.
Documentation ”“ Plan administrators must show that they acted prudently and solely in the interest of the plan participants and beneficiaries. The best way to do this is to document the decision-making process at the time any decision is made.
Insurance ”“ Generally, anyone handling plan funds or property will need to be covered by a fidelity bond. This protects the 401(k) plan against fraud or dishonesty from a particular individual.
Loans ”“ If plan participants take loans from their 401(k) accounts, you must be sure that loan payments start on time and continue until the loan in fully paid. Otherwise, the participant is stuck with a tax liability.
Eric Meermann is a client service manager and portfolio manager with Palisades Hudson Financial Group in Scarsdale. He can be reached at eric@palisadeshudson.com.
