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Do You Know Your Retirement Plan Document?

3/31/21

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This guest article was authored by representatives with HORAN, Graydon, and TPA, division of Latitude.

Have you ever walked into an automobile dealership to buy a vehicle only to find yourself confused by the options available on the same style of vehicle? There’s the base model, which gets you from here to there and has a few but not many creature comforts. The LX is an upgraded version with a few additional bells and whistles. The EX has even more upgrades but not as many as the premium EX-L. Finally, if you love driving, the sport edition might be best.

So, what does a retirement plan document have to do with buying a car? Nothing and everything. The point of the auto analogy is you ultimately choose the vehicle that fits your needs and your lifestyle. You pick the features you want or cannot live without. You ignore the features that simply do not fit your lifestyle or needs or budget. Your retirement plan and its governing provisions (via the plan document) should be approached in that same manner. Your retirement plan document can and should be designed based on your company and your employees' values and needs.

One of the top findings by VonLehman in a plan audit is the failure to follow the provisions of the plan document. Is this important? Important enough that the governing rule of retirement plans, the Employee Retirement Income Security Act (ERISA), has a specific fiduciary provision [Section 404(a)(1)(d)] that requires retirement plans to be governed according to the terms of the plan document. Important enough that failure to administer the plan according to the terms of the governing document can land the plan fiduciaries in hot water with the IRS and/or the Department of Labor. Fines, penalties, corrections, reversals are all added costs that can effectively be avoided.

How important is the plan document for your employees’ success with retirement savings? Certain retirement plan provisions can lead to wildly successful or wildly unsuccessful retirement savings. T. Rowe Price in its white-paper, “Auto-Enrollment’s Long-Term Effect on Retirement Saving,” identifies the auto-enrollment provision as transforming the way millions of Americans save for retirement. It notes that plan participation almost doubles and successfully gets participants who might otherwise not be saving to save for retirement. Further, auto-escalation – where annual incremental increases in deferral rates happen automatically – combined with auto-enrollment, may create even better savings outcomes.

Contrast those two features with a similar type of retirement plan that does not have auto-enrollment nor auto-escalation features and, instead, uses a cookie-cutter approach of IRS maximum guidelines requiring employees to wait one year following employment and attain age 21 or older before they can enroll on the first day of the next calendar quarter. How many ‘new’ employees will voluntarily sign up to defer into their retirement plan and effectively incur a take-home paycut after getting used to a full net paycheck for the past 12 to 15 months? If the employees don’t voluntarily sign up or they sign up but at lower contribution levels, what will their retirement outcomes look like? Vanguard reports in its “How America Saves 2020, Insights to Action” that 61% of participants voluntarily enroll versus 92% participation rates when the plan has auto-enrollment features. The participation rate drops to 44% for employees under age 35. These figures are not good for employees’ retirement savings success.

Plan design doesn’t just impact the employees, it also impacts the plan sponsor. Many plan sponsors adopt a safe harbor plan using the basic safe harbor formula which also requires 100% vesting in the employer’s safe harbor match. Effectively, an employee participant contributes 5% of his/her compensation and receives a 4% employer match that the employee owns outright. This enables the highly compensated employees (those earning more than $130,000 in a calendar year, a 5% owner or a relative of a 5% owner) to defer up to the IRS maximum without having any deferral (and related income, and possible employer match) returned due to a compliance testing failure. Is this the right safe harbor formula for the employer? What if an employer experiences heavy turnover in the first six months or one-year of employment? Did the employer know that using a Qualified Automatic Contribution Arrangement (QACA) will create the safe harbor, introduce a 2-year cliff vesting schedule, provide for auto-enrollment and auto-escalation and, if desired by the employer, reduce the employer match to 3.5% requirement IF the employee contributes 6% of compensation?

Another effect of plan design centers on overall plan operational cost. Most recordkeepers use a combination of asset market value, the number of plan participants and/or average participant account balance to arrive at their required revenue to operate a retirement plan. A lower participant average account balance most often results in higher fee rates by the recordkeepers. Plan design techniques that include utilizing automatic cash-out distribution and automatic rollover rules help plan sponsors drive down participant count and eliminate the under $1000 and the under $5000 vested account balances, respectively. So, washing out smaller balances of terminated employees may actually improve overall fees charged by providers. This is not to mention that maybe, just maybe, keeping the participant count below the audit threshold can help reduce or defray additional plan costs.

While we’ve addressed a number of ideas in and around plan design, the real call to action is to sit down with your providers – your recordkeeper, third party administrator (TPA), auditor, trusted retirement-dedicated advisor, benefits attorney – to really learn how your plan is currently designed. Any, and really all of them, should be able to walk you through the provisions of your plan and educate you on IRS requirements, provision flexibility, and regulatory aspects for each of the key retirement plan provisions.  Now is a good time to undertake this review. Every 6 years the IRS requires most company-sponsored retirement plans to restate their plan document. For defined contribution plans, which include 401(k) plans, that process is called the “Cycle 3” restatement. It commenced on August 1, 2020 and ends on July 31, 2022. The restatement is mandatory and requires the adoption of a rewritten plan document. It also offers the ideal opportunity for Plan Sponsors and their service providers to review the plan provisions. If any changes are needed, they can be incorporated into the plan restatement. Spending time now to review the plan design will result in a retirement plan that better meets the needs of the Employer and the Plan Participants.

As one example of the process: HORAN recently successfully onboarded a client that moved from a pooled investment, periodically-valued approach to the more traditional participant-directed investment approach consistent with a daily-valued 401(k) plan. As an advisor with expertise in plan design, HORAN identified key provisions in the current plan, listed corresponding IRS requirements, listened generously to the wants and needs of the plan sponsor, and coordinated a series of consultative discussions that also involved Latitude/Tri-State Plan Administration and Graydon. The result is a plan design that fits the plan sponsor’s needs, provides for additional flexibility for the future, and a much greater understanding of how the plan works and operates in conjunction with payroll, the recordkeeper and the TPA. Administration should be understandable and easier as a result.

Our overriding message: Don’t let your provider(s) simply dictate the terms of YOUR plan design. The employer should take the time to fully understand the key elements of the plan to help ensure that the plan design fits the immediate and anticipated future needs of the employer and its employees. Afterall, a retirement plan is a benefit to help hard working Americans save for retirement and retire successfully.