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Change Can Be a Good Thing

Is your 401(k) working for you the owner group and your employee? If your 401(k) plan isn’t a good match for your company, it may leave your company at a competitive disadvantage for attracting and retaining talent and may also limit contributions for owners. All 401(k) plans must undergo certain compliance testing requiring a certain level of employee participation, and low participation rates from employees in general, tend to result in contributions being returned to owners, resulting in additional taxes.

Making sure your company has expert external service providers is crucial to minimizing these risks, while also serving as a pivotal part
of plan administration and oversight. The right provider will not only deliver high-quality service but will help in designing and administering the best plan for your company.

If you feel it is time to consider a switch in your providers, there are several things to keep in mind:

Consider Your Options Before You Begin

Open Communication with Auditors. We are here for you! We audit many varied plans that have many different third-party administrators, custodians and advisors. We are always happy to connect you with high-quality service providers based on our and our clients’ first-hand experiences.

Timing Is Important

Of course, your company’s seasonality should be considered, but keep in mind that when a plan switches at any time mid-year, it is often much more difficult and costly to perform the DOL required audit. Switching providers at year-end is more seamless as there is only one service provider and one set of reports.

Make Sure You Can Access Your Data

When a plan changes service providers, sometimes full access is lost to the websites and reports needed for record retention as well as for compliance purposes, such as the audit. It is important to maintain access to the information. If we know about the change in advance, we can help you download the reports you’ll need.

Additional Thoughts

Planning ahead is key to avoiding disruptions. Employees may need to attend a few meetings or educational events. Make sure you work with the new service provider and your payroll service to address any technical details to ensure there are no payroll disruptions during the switch. A black-out notice will also be required during the switch. This informs the participants that the benefit plan is switching service providers and there will be a certain period where deferrals will not be made and the participants will be unable to access the website. You will also need records of the fund mapping. This mapping provides information on the fund transfer process between the service providers. Lastly, if your administrator provides the ERISA bond, it is important to make sure your new service provider offers an ERISA bond or that you get one separately.

As always, we would be happy to schedule a meeting or a call to go over any of these items in more detail.

By Molly Mayer, Associate Accountant

Adding a Roth 401(k) option could boost employee savings

A decade after they first became available, Roth 401(k) plans are now offered by many employers. Employees are also getting on board — particularly the younger ones — even without fully understanding how they work, a Harvard study suggests.

Roth 401(k) vs. Roth IRA vs. traditional 401(k)
Roth 401(k) plans operate on the same principle as their older cousin, the Roth IRA: Participants make contributions on an after-tax basis, but qualified distributions are tax-free. (Any employer-matching contributions, however, are pretax and must flow into a separate account.)

Roth 401(k)s have an advantage over Roth IRAs for highly paid employees: Participation eligibility isn’t capped by income. The only cap is the annual 402(g) limit imposed by the IRS for employee deferrals.

An advantage of a Roth 401(k) over a standard 401(k) is that participants can avoid required minimum distributions (RMDs) after age 70½ by rolling their Roth balance into a Roth IRA. This allows those dollars to accumulate tax-free indefinitely, and be passed on to heirs, if participants choose.

Can participants borrow money from their Roth IRA? The short answer: Not really. Unlike many employer-sponsored retirement plans like 401(k) plans that allow participant loans, there’s no such thing as an “IRA loan.”

Finally, in the opposite scenario (a participant wants to access funds sooner), the Roth 401(k) has another advantage over a traditional 401(k): Before age 59½, Roth 401(k) participants can tap into principal amounts contributed to their account (but not investment returns) without a 10% early withdrawal penalty. They must, however, have been in the plan for at least five years to take advantage of that opportunity.

Employee participation

Roth 401(k)s make more sense financially for some employees than others; offering employees both kinds of 401(k)s leaves it up to them to decide which is better. T. Rowe Price, for example, reports that 61% of employers in its client database offered a Roth option in 2016, a 10% jump from 2015. According to T. Rowe Price’s data, the percentage of 401(k) participants with access to Roth 401(k)s who then made contributions to a Roth 401(k) was about 6% in 2016, down from 7% in 2015. However, this drop may be explained by the 10% increase in availability of the Roth option from 2015; many employees haven’t had a chance to warm up to the new option yet.

More detailed research from Alight Solutions, a consulting firm, indicates that, when the participation rate data is sliced by age bracket among employees who have access to a Roth 401(k) plan, the numbers are more impressive. For example, it found that in 2016 close to 20% of employees in the 20 to 29 age bracket who have the option to take advantage of the Roth option do so. Participation rates drop for each successive older age bracket, down to around 11% for employees in the 40 to 59 age range, and 7% for the 60-plus cohort.

That pattern suggests that some participants could be following general advice offered with respect to who is best suited to take advantage of a Roth. According to conventional wisdom, younger employees are in lower tax brackets because they tend to earn less than older participants. That means that the opportunity cost of missing out on making their 401(k) contributions on a pretax basis is lower than it would be for someone in a higher tax bracket.

For example, it would cost a single-filer employee with a federal marginal tax rate of 15% only $750 in forgone federal income tax savings to contribute $5,000 to a Roth 401(k), and nearly twice that amount ($1,400) for a single filer in the 28% tax bracket.

Employee knowledge

But are employees performing this kind of analysis? The conclusion of a recent study by Harvard University researchers suggests that perhaps they aren’t, which in turn also suggests that Roth 401(k)s are a particularly good option to put in front of employees.

According to the Harvard study, when participants switched to a Roth 401(k), they maintained the same deferral rates they had been using with the conventional 401(k) plan. If the employees who made that switch had analyzed the implications of doing so, they would have realized that, by making their 401(k) deferrals on an after-tax basis, they could afford to reduce their deferrals, and wind up at retirement with the same amount of money. How? Because those funds wouldn’t be reduced by taxes when they took their distributions in retirement.

“Our survey experiment provides suggestive evidence that employee confusion about and neglect of the tax properties of Roth balances… prevent contribution rates from falling following a Roth introduction,” the study concludes. The upshot is that “the total amount of retirement consumption being purchased via the 401(k) increases after the Roth is made available.”

Smart saving

Adding a Roth option to your 401(k) may help your employees to effectively save more than they otherwise would have. That’s a win for everyone.

Tax cut law a mixed bag for retirement plan sponsors

Tax cut law a mixed bag for retirement plan sponsors

Despite early indications that Congress was prepared to do much more, the Tax Cuts and Jobs Act (TCJA) that was passed in December largely left retirement plans unscathed, save for changes pertaining to plan loans and IRA conversions. Here’s a quick review of areas that are affected, as well as what could be ahead.

Plan loan relief

The new law gives a break to plan participants with outstanding loan balances when they leave their employer. Ordinarily, participants with outstanding loans who fail to make timely payments after their separation from the employer are deemed to have received a distribution in the amount of that outstanding balance. Under pre-TCJA law, they could, however, roll that amount (assuming they have sufficient funds available) into an IRA without tax penalty if they do so within 60 days.

Under the TCJA, beginning in 2018, former employees in this situation will have until their tax return filing due date (including extensions) to move funds equal to the outstanding loan balance into an IRA or qualified retirement plan without penalty. They’re given the same opportunity if they’re unable to repay a loan due to the plan’s termination.

Roth IRA Recharacterization

The TCJA also restricts individuals’ ability to recharacterize conversion contributions to a Roth IRA as if they were still making contributions to a traditional IRA. In other words, beginning in 2018, individuals can no longer convert a traditional IRA to a Roth IRA and then later recharacterize that Roth IRA contribution back to a traditional IRA contribution to essentially undo the conversion. However, taxpayers can still recharacterize new Roth IRA contributions as traditional contributions as long as they do it by the applicable deadline and meet all other rules.

While not immediately pertinent to plan sponsors, this provision may be a warning shot across the bow with respect to possible future restrictions on 401(k) plans. Roth 401(k)s are favored by revenue-seekers in Congress, because the after-tax nature of contributions to Roth plans — IRAs or 401(k)s — enables the federal government to collect more tax revenue in the present, pushing off into the future the drain on tax revenue due to the tax-free nature of withdrawals from Roth plans.

Higher costs for passthrough entities?

The American Retirement Association (ARA) expressed concern that the TCJA’s tax-cutting features applicable to pass-through entities like S corporations could discourage 401(k) plan sponsorship. Specifically, allowing taxpayers to deduct 20% of qualified business income could make 401(k) plans, in effect, costlier to owners of S corporations on an after-tax basis, if they couldn’t apply their tax deductions for their 401(k) contributions to their more highly taxed personal income instead of their qualified business income.

It’s not clear, however, that increasing, by possibly a relatively small amount, the after-tax cost of maintaining a 401(k) plan to a business owner would warrant terminating a plan when weighed against other benefits to the business associated with sponsoring such a plan.

Looking ahead

The fact that several provisions detrimental to retirement plans made it to the debate stage and even into early drafts of tax reform bills could open the door to future efforts to restrict plans’ tax benefits. The need for federal revenue will continue, with the government looking for places to collect that revenue.

One provision that cleared the Senate Finance Committee, but was ultimately dropped, would have required that all contributions to any defined contribution plan sponsored by the same employer (including mandatory employee contributions to a defined benefit plan) be aggregated when determining whether contributions to a participant’s account satisfy IRC Sec. 415(c) limits. That change would have raised $1.7 billion over a 10-year period, the Committee’s staff estimated.

Similarly, Congress considered imposing a low ($2,400) cap on pretax 401(k) contributions, requiring the balance of the total $18,000 limit on contributions to be made on an after-tax basis. Congress could revisit that concept and push employers to convert traditional 401(k) plans to Roth plans, if budget deficits balloon, the ARA warned, echoing the concerns also expressed by the American Benefits Council.

Retirement Benefit Plan Limitations

Retirement Benefit Plan Limitations