When a tax-exempt organization decides to establish a retirement Plan, the starting point is usually whether to adopt a 401(k) Plan or a 403(b) Plan.
While that’s an important decision, it may not be the best place to start.
Most discussions begin by comparing the features of 401(k) and 403(b) Plans. While those comparisons are helpful, they don’t necessarily lead to the best decision.
Instead, start by asking a different question:
What are we trying to accomplish?
No two organizations are exactly alike. Their mission, size, location, workforce, financial resources, administrative resources, and long-term objectives all influence which retirement Plan is the better fit.
Once those objectives are clear, the choice between a 401(k) Plan and a 403(b) Plan often becomes much easier.
The retirement Plan should support the organization—not the other way around.
That means stepping back before comparing Plan provisions and asking questions such as:
Why are we establishing a retirement Plan?
What do we want this Plan to accomplish for our employees?
How important is administrative simplicity?
Will this Plan support our organization as it grows and changes?
Will this decision still make sense five or ten years from now?
Only after answering those questions does it make sense to compare providers, investment options, Plan provisions, and fees.
There is no universally “best” retirement Plan. There is only the retirement Plan that is the best fit for your organization.
A thoughtful decision-making process won’t guarantee a perfect outcome. It will, however, significantly increase the likelihood of selecting a retirement Plan that supports the organization’s mission while helping its employees prepare for retirement.
Every employer maintaining a pre-approved defined contribution retirement plan—including 401(k) and 403(b) Plans will need to update their documents by December 31, 2026 to maintain reliance on IRS approval.
401(k) Plans will need to adopt amendments reflecting SECURE 2.0, the most significant retirement plan legislation enacted in many years.
403(b) Plans will need to be restated for what is called Cycle 2, the IRS requirement that 403(b) Plan documents be restated updated to reflect regulatory and legislative changes over the last several years.
While the immediate objective is compliance, the amendment process also provides an opportunity to review the effectiveness of your retirement plan.
Too often, Plan Sponsors view required plan amendments and restatements as simply an administrative exercise — review the documents, sign the required paperwork, distribute participant communications, and move on.
While that approach satisfies the technical requirement, it may overlook an opportunity to review and improve important aspects of your retirement plan, including:
Governance and fiduciary oversight
Service providers and service delivery
Fees and expenses
Participant outcomes
Plan design
Administration and operations
The following six questions can help you determine whether your retirement plan continues to meet the needs of your organization and employees.
1. Are We Meeting Our Fiduciary Responsibilities?
Fiduciary responsibility begins with having a prudent process for making decisions and monitoring a 403(b) Plan. The amendment process provides an excellent opportunity to review governance procedures, committee structures, and the responsibilities assigned to internal personnel and service providers.
2. Are We Receiving the Type of Service We Need?
The needs of an organization change over time. Employee demographics change. Regulations change. Service providers change.
The amendment process provides an opportunity to determine whether the current service model for your 403(b) Plan continues to meet the organization’s needs and objectives.
3. Are We Receiving Value for the Fees Being Paid?
Plan Sponsors should understand what services they receive and what those services cost. Reviewing and benchmarking the expenses of a retirement plan can help determine whether fees remain reasonable and whether participants are receiving appropriate value for those costs.
4. Are We Helping Participants Prepare for Retirement?
A successful retirement plan is measured by more than compliance. Participation rates, deferral rates, employee education, and participant communications all affect retirement readiness.
The amendment process provides an opportunity to evaluate whether your retirement plan is helping participants achieve their long-term retirement goals.
5. Are We Taking Advantage of Available Plan Design Opportunities?
SECURE 2.0 provides Plan Sponsors with additional design options. While not every provision is appropriate for every organization, the amendment process provides a natural opportunity to evaluate whether changes to your retirement plan could improve participant outcomes.
It is also an opportunity to determine whether your retirement plan continues to support the organization’s objectives and workforce demographics.
6. Is Your Retirement Plan Being Operated in Accordance with the Plan Document?
Many compliance issues result not from defective documents, but from operational practices that differ from the written terms of the plan.
Eligibility, contributions, loans, hardship distributions, and administrative procedures should all be reviewed periodically to confirm that the operation of the plan remains consistent with its governing documents.
The Opportunity
401(k) and 403(b) Plan Sponsors will need to adopt amendments and restatements respectively by December 31, 2026.
This is an opportunity to use these compliance requirements as a catalyst for a review of your retirement Plan.
The question is whether you will use the process to improve your retirement plan.
Employers who have adopted a pre-approved Pension Plan – either traditional Defined Benefit or Cash Balance – must restate their plans by March 31, 2025 to stay in compliance with the Internal Revenue Code (“Code”) and Internal Revenue Service (“IRS”) regulations.
If you’re not part of our retirement plan world, both the law and regulations can be complicated and confusing. To help you understand what’s required and how to take advantage of the required Restatement process, here is a Plain Language explanation in a Question and Answer format.
Since the passage of ERISA in 1974, retirement plan legislation has been a series of technical and tax-related changes. The Revenue Act of 1978 started out the same way with its focus on:
Increasing economic growth through income tax reductions to stimulate consumer and investment spending, and
Improving equity in the tax system and simplifying it.
Sometimes during the legislative process an unrelated provision is added to the law. That’s what happened here. Section 401(k) found its way into the Internal Revenue Code. In one fell swoop, this new Code Section replaced what was then the primary employee retirement saving vehicle, “After-Tax Thrift Plans”, which were retirement savings plans to which employees made contributions on an after-tax basis.
This new Section 401(k) allowed employees to make those contributions on a pre-tax basis. It also provided a comfort level to employees that their accounts would not be locked up until the traditional age 65 retirement age. It also permitted access to those funds with in-service distributions at age 59½, upon severance from employment, or because of hardship or disability.
SECURE 2.0 which Congress passed 46 years later went significantly further. Passed at the tail end of 2022 as an extension of the 2019 SECURE Act, there were 92 provisions in approximately 400 pages with four major themes:
Expanding participant coverage.
Encouraging retirement savings.
Helping participants preserve income.
Simplifying retirement plan rules and administrative procedures.
SECURE 2.0 is also different for two other reasons.
First, there are optional and mandatory provisions. A plan sponsor can adopt the optional ones, or not, based on the plan’s objectives. The mandatory provisions, on the other hand, must be timely adopted by plan amendments to maintain the plan’s tax qualification.
Second, the effective dates of the various provisions are staggered. Provisions are effective in 2023, 2024, 2025, and beyond. These staggered effective dates provide breathing room for the IRS to provide guidance, for the retirement plan industry to make the necessary changes to administrative systems and documents, and for plan sponsors to make the best decisions for their retirement plans.
Kids will outgrow their clothes. Sometimes that happens with retirement plans.
If you have a SIMPLE IRA, it may have fit in the beginning. But if you want to change to a 401(k) plan in 2024, you need to take action by November 2. That’s the date that employers must provide notice to their employees that 2023 will be the last year for the SIMPLE IRA, and that it will be replaced by a 401(k) plan in 2024.
But keep reading because a new tax law which providres for a mid-year replacement is discussed later.
Reasons to Change
A SIMPLE IRA is relatively easy and inexpensive to administer. 401(k) plans, on the other hande, are more complicated and expensive but have features that businesses (and business owners) can take advantage of. 401(k) plans can:
Provide larger tax-deductible contributions.
Favor owners and highly compensated employees.
Require more employment service to be eligible to participate.
Provide a graded vesting schedule.
Allow for plan loans.
Provide better creditor protection.
Be able to buy tax-deductible life insurance.
Extended Deadline
As mentioned above, the November 2 deadline has been extended. Starting in 2024, the new SECURE 2.0 tax law allows an employer to replace a SIMPLE IRA mid-year with a safe harbor 401(k) plan. The 401(k)-replacement plan must be effective as of the termination date of the SIMPLE IRA. There are two planning considerations to the new law:
401(k) Deferral Limit. Employees would be restricted to an aggregate elective deferral limit including catch-up contributions during the replacement year. The limit is based on the number of days covered in each plan.
Rollovers/Transfers. The tax rules regarding a rollover or transfer from a SIMPLE to another qualified retirement plan have stayed the same. In general, an employee cannot transfer money tax-free to a 401(k) plan during the 2-year period beginning when the employee first participated in the SIMPLE. The 2-year period begins on the first day on which the employer deposits contributions in the employee’s SIMPLE.
The Right Answer
There isn’t one. Just like the visual metaphor used for this blog post, it’s whatever fits best.
The deadline for restating a 401(k), profit sharing, or money purchase pension plan has come and gone. So, what can an employer do? It was, after all, the employer’s responsibility to ensure that the plan was updated and signed by July 31, 2022.
But if an employer did miss that deadline, there is a Plan B. But first let’s put July 31, 2022, into context. That’s the date the IRS required pre-approved plans to be updated for the last 6 years of legislative and regulatory changes.
It’s referred to as a “Cycle 3 restatement” in the retirement plan world and allows the employer to have “reliance” that the document meets the current requirements of the law and regulations. Here is a link to our FAQs from last year that will bring you up to date.
So what’s the impact on an employer’s plan that didn’t restate its plan by the July 31, 2022 deadline? It’s a good news-not so-bad news situation.
The good news is that the IRS does not consider that the failure to timely restate the plan will itself disqualify it from favorable tax treatment.
The not-so-good news is that the failure transforms that pre-approved plan into an individually designed plan upon which the employer can no longer rely as a qualified plan. The Plan B mentioned above would be for the employer to adopt corrections under the IRS Self-Correction Program and consider whether to obtain formal approval through its Voluntary Correction Program.
You may be wondering if there is a Plan B, is there also a Plan C? Not exactly, and it’s certainly not voluntary. It’s the IRS’ Audit Agreement Closing Program (“Audit CAP”) which is the end result of a plan audit. If the IRS finds the plan to be non-compliant, the employer would be required to submit an updated plan to avoid disqualification. The cost of which would be significantly more than if the missed deadline was dealt with on a voluntary basis.
The takeaway should be obvious: Contact them before they contact you.
From the beginning of 401(k) plans, the retirement industry has focused on the performance of individual funds as the key driver of retirement readiness. But a study by the Putnam Institute in 2006 and repeated in 2012 concluded that increasing deferral rates have the greatest potential impact on a 401(k) participant’s account balance at retirement
The Putnam Study, Defined Contribution Plans: Missing The Forest For The Trees?, showed that fund selection was actually the least important factor compared to asset allocation, account rebalancing, and increased deferrals. The most important? Increasing deferral rates.
Putnam arrived at this conclusion by simulating different portfolios of mutual funds in a hypothetical, but typical, 401(k) plan. Here is how the study can be viewed from a plan sponsor’s perspective:
Plan Activity
Time Spent
Relative Importance
Selecting Funds
Most
Least
Allocating Assets
More
Lesser
Rebalancing Accounts
Lesser
More
Increasing Deferral Rates
Least
Most
One way – maybe the best way – to increase deferral rates is through auto-enrollment and auto-escalation. Congress thinks so. As part of the recently passed SECURE 2.0 employees are automatically enrolled in a 401(k) plan at 3% of compensation. The amount is increased each year by 1% up to at least 10% but not more than 15% of the employee’s compensation. There’s a plus for the employer: tax credits may be available.
Because there are now five generations in the workforce for the first time:
Traditionalists—born 1925 to 1945
Baby Boomers—born 1946 to 1964
Generation X—born 1965 to 1980
Millennials—born 1981 to 2000
Generation Z—born 2001 to 2020
The challenge to create and provide a 401(k) plan is arguably more difficult now than it ever was.
401(k) plans are part of the big picture which includes dealing with such questions as
What kinds of challenges are present for today’s employers?
How do generational workforce differences affect our ability to manage people effectively?
What are the traits, beliefs, and life experiences that mark each generation, influencing how they work, communicate, and respond to change?
Dr. Bea Bourne, DM, is an expert on generational differences and generational responses to organizational change. She is a faculty member in the School of Business and Information Technology at Purdue University Global. In the infographic that follows, she shares her research regarding:
How today’s talent stacks up by generation, including their defining values, beliefs, and worldviews
The significant historical events that shaped each generation
How to best motivate and manage workers from each generation
In the 401(k) and 403(b) world, we’ve got a tool. It’s called Plan Design and it’s been significantly enhanced by the recently passed SECURE 2.0 legislation. There will be more about that to follow as IRS guidance and recordkeeper platform capabilities develop.
“Compensation” is a timely topic now for employers with retirement plans. It’s that time of the year when decisions are made about retirement plan contributions. The starting point for those decisions is “compensation”.
That starting point is a straightforward matter when employees are involved. It’s some variation of taxable wages reported on Form W-2.
But for sole proprietors, partners in a partnership, or members of a limited liability partnership, compensation is more complicated. It’s “Earned Income”, the Internal Revenue Code’s version of a calculus equation. Here’s why.
That’s the box that has to be checked by July 31, 2022. It’s the date the IRS requires that your 401(k) plan, profit sharing plan, or other defined contribution plan be restated to be in compliance with recent tax law changes. Here is a plain language explanation in Q and A format to help you understand why July 31 is one of those “don’t miss” dates: Continue Reading
