How Does Your 401(k) Plan Measure Up?
There are about 60 million Americans covered by 401(k) plans. They are the most prevalent form of retirement plan in the United States, with more than 500,000 set up across the country, according to the U.S. Department of Labor.
The IRS recently surveyed 401(k) plan sponsors to evaluate whether they are in compliance with tax laws and to determine how organizations use 401(k)s.
Here are some of the key findings from the "Section 401(k) Compliance Check" report, which was issued by the IRS Tax Exempt and Government Entities Division.
Requirements for Allowing Participation in the Plan
A section 401(k) plan may require that an employee meet specified age and/or service requirements to be eligible to participate in the cash or deferred arrangement. Here are the results from the approximately 1,060 survey respondents on whether they have two requirements:
|Plans that restrict participation to those with one year of service||54 percent|
|Plans that restrict participation to those age-21 and older||64 percent|
The survey found that as the plan size increases, the requirement to be at least age 21 decreases. Very large plans (defined as those with more than 2,500 participants) are more likely than smaller plans to have no age requirements.
A covered employee can elect to have an employer contribute a portion of his or her cash wages to a 401(k) plan on a pre-tax basis. The dollar amount is limited under tax law. For 2013, it is $17,500 with an additional $5,500 for those who are age 50 and older by the end of the plan year.
Generally, these deferrals are not included as taxable wages for income tax purposes on an employee's Form W-2 when made to the plan and are not included in an employee's income until distributed from the plan. However, these deferred wages made to the plan are subject to Social Security, Medicare, and federal unemployment taxes.
Many 401(k) plans provide matching contributions on elective deferrals on the basis of a percentage of the amount deferred or the dollar amount deferred.
Here are some survey results related to contributions.
|Employer makes matching contributions||68 percent|
|Plans that have a one-year-of service requirement before participants are eligible for matching contributions||58 percent|
|Sponsors that suspended or discontinued matching contributions in 2006||1 percent|
|Sponsors that suspended or discontinued matching contributions in 2008||4 percent|
|Sponsors that suspended or discontinued matching or non-elective contributions from 2009 to 2012||15 percent|
|Plans that allow participants age 50 and older to make catch-up contributions||96 percent|
|Plans that provide for some form of employer non-elective contribution, such as a profit-sharing contribution||65 percent|
|Plans that permit employees to make designated Roth contributions (after- tax salary deferral contributions)||22 percent|
Of the 401(k) plans that do allow designated Roth contributions, 14 percent have initiated an eligible rollover distribution to another designated Roth IRA or account. Of the plans that do notpermit designated Roth contributions, the reasons given were: employees would not be interested; it would be administratively burdensome; the rules are too complicated; it would be too expensive; and the plan's service provider does not offer the option.
Hardship Distributions and Loans
Qualified retirement plan rules generally restrict participants' access to their 401(k) balances before they cease employment. Two exceptions to this general principle are:
- Hardship withdrawals, which are distributions to participants from their vested account balances in the event of an immediate and heavy financial need. These events include making payments for medical expenses, the purchase of a primary residence, education expenses, funeral costs, home repairs and to prevent foreclosure.
- Participant loans, which can be allowed by participants from their vested account balances, provided to meet certain rules and restrictions.
|Plans that permit hardship distributions||76 percent|
|Plans that allow participant loans||65 percent|
|Plans with an increase in outstanding participant loans from 2006 to 2008||47 percent|
|Plans with an increase in defaulted participant loans from 2006 to 2008||60 percent|
When making a participant loan, a plan must charge a reasonable rate of interest or it is considered a prohibited transaction. Of the 401(k) plans that allow participant loans, 16 percent charge the Prime Rate, 46 percent charge the Prime Rate plus one percent, 19 percent charge the Prime Rate plus two percent and the rest charge other rates.
Another loan requirement: Under tax law, a loan from a 401(k) plan must generally be repaid within five years or it will be deemed a taxable distribution. A longer repayment period is allowed if a loan is used to acquire a principal residence. For plans that allow loans, the majority required them to be repaid in installments every pay period (81 percent). The rest required participants to make payments quarterly (11 percent) or at another interval.
Top-Heavy and Non-Discrimination Rules
A section 401(k) plan is generally subject to certain non-discrimination requirements to ensure that higher-paid employees do not defer amounts to the plan that are significantly more than amounts deferred by lower-paid employees. However, an employer may adopt a more simplified plan, known as a "safe harbor" plan, which automatically meets the requirements and does not require the employer to conduct non-discrimination testing.
Under tax law, a 401(k) plan is "top-heavy" if the aggregate amount held in the accounts of key employees exceeds 60 percent of the aggregate amount held in the accounts of all employees. If this occurs, the plan must meet special minimum contribution requirements.
The term "key employee" generally refers to an employee who, at any time during the plan year, is:
- An officer of the employer with annual compensation greater than $165,000 (as adjusted for increases in the cost-of-living);
- A 5 percent owner of the employer; or
- A 1 percent owner of the employer having annual compensation of more than $150,000.
|401(k) sponsors that identify their plans as top heavy||20 percent|
|401(k) sponsors that state their plans are not top heavy||5 percent|
|401(k) sponsors that state the top-heavy rules do not apply to them||25 percent|
|Safe harbor plans||43 percent|
Want to Boost Enrollment?
If your company wants to increase enrollment in its 401(k) plan, here are some quick considerations:
- Shorten or eliminate enrollment waiting periods for new hires.
- Provide a matching contribution. Reinstate a matching contribution if you eliminated it during the recession.
- Offer plan loans and hardship withdrawals to reassure employees they can tap their balances in a crisis.
- Make a broad array of investment options available.
If you would like more information about your 401(k) plan, consult with your employee benefits or tax adviser.