Hello and welcome to your sophomore year at 401K University! This segment of the curriculum focuses on plan design. As most of my plan sponsors implement a retirement plan to recruit higher caliber talent and retain their key employees, we need to make sure we design the retirement program to address each of these goals.
Plan design is what allows your retirement program to function in the real world as you are envisioning it in your mind. This segment of the course will review topics such as participant eligibility, employer contributions, vesting schedules, contribution options, compliance testing, and other plan provisions.
This can be a lot of information to digest so let's start with the basics. First, we need to know that a 401(k) is what’s known as a qualified plan. A qualified plan is an employer-sponsored retirement program which can receive favorable tax treatment under Section 401(a) of the Internal Revenue Code. In order to offer a qualified plan, you must have a plan document in place. The plan document outlines all of the rules and regulations of the retirement program. Without a qualified plan document, you cannot have a qualified plan. Now, although it is technically the Third-Party Administrator’s role to design and oversee your plan document, it can only help you to know your plan design options so you’re building the right 401(k) for your particular group of employees.
When I have a plan sponsor who would like to offer a new retirement benefit or evaluate an existing plan, we usually start by determining which of the two basic plan structures they would like to implement. The easiest way to start is to define the differences between the Traditional 401(k) and the Safe Harbor 401(k) Plans. Let's take a high-level look at each of these programs.
The Traditional 401(k) plan offers the most flexibility because the employer can determine the matching schedule or make no company contributions at all under this program. The employer can also select different eligibility requirements for the employee to enroll in the plan versus receiving any potential company contributions. Also, the employer has the ability to assign a vesting schedule for any potential employer contributions to encourage employee retention. However, this program is subject to compliance testing. We’ll go deeper into compliance testing later in the course but, for today, all you need to know is that owners and certain highly-compensated employees may be limited as to how much they can contribute to the retirement program under the Traditional 401(k) Plan.
The other program available to you is the Safe Harbor 401(k) Plan. The primary benefit of this program is that all participants have the ability to defer up to the maximum contribution limits for the year ($19,500 for 2021) without fear of passing compliance testing. If you are setting up the retirement plan with the goal of the owners and highly-compensated employees being able to participate in the plan and potentially maximizing their contributions, the Safe Harbor 401(k) may be the right plan for you. However, the Safe Harbor 401(k) has certain requirements that you must adhere to. First, the employer must commit to making an employer contribution on behalf of the participants. Second, the employer cannot setup different eligibility requirements for the employees to enter the plan versus receiving these company contributions. The final requirement of the Safe Harbor program is that these company contributions are deemed fully vested on behalf of the participants.
Join us next week when we'll review the Traditional 401(k) Plan in more depth to see if this is the right program for your particular group of employees…