Newslink: Retirement

September 2014
The Top Ten Things to Do If Your 401(k) Plan Fails Nondiscrimination Testing

401(k) plan sponsors generally do not relish the annual call from their 401(k) consultant with their plan's nondiscrimination testing results. If your plan regularly passes testing, that's great news. However, if you are not so fortunate or your plan is on the cusp, there are steps you can take to greatly increase your plan's chances of success. This article discusses those choices.

    • Assess alternate testing methods. A technically savvy retirement plan consultant may be able to get your plan to pass using a testing method different from the one you have customarily used. If your plan just barely passes with an alternate testing method, you most likely will still want to consider making some changes to ensure a better outcome in following years.
    • Make any necessary refunds. Once your plan fails the testing, you must take corrective measures to keep your plan qualified — doing so is not optional! Generally, the first step is to reduce the contributions incurred by the highly-compensated participants to the point where the plan will pass the tests. Those highly-compensated employees who defer the most in dollar terms receive refunds first. Refund distributions are taxable in the year in which they are made. This, of course, creates communications issues with the higher-paid employees. If the failure appears to have been an aberration, you may be able to treat it as such. If it appears to be part of a trend, you may want to advise affected employees to reduce their deferral percentage to minimize their refund, or to be prepared to receive refunds in future years.
    • Consider making a Qualified Non-Elective Contribution (QNEC) or Qualified Matching Contribution (QMAC). If cutting back the highly compensated employees' contributions is highly unpalatable, there are other options. A QNEC is an employer contribution that is made to the plan on behalf of every eligible employee, whether or not he/she contributes to the plan. A QMAC is an employer matching contribution that is allocated only to those employees who defer. The employer would need to contribute enough money to make the plan pass the nondiscrimination test. Most employers do not take these approaches because doing so is expensive, and because the employer contributions are 100% vested immediately.
    • Institute automatic enrollment. The most proven way to boost participation is to institute automatic enrollment for all employees, not just those newly eligible to participate in the 401(k) plan. A recent survey showed that employers who enroll only those who are newly eligible see, on average, only a 1% increase in participation. Because so many employees just don't take action when left to their own devices, automatic enrollment for all employees can easily increase participation rates from the typical high-60% range into the 90% or higher range. Some employers automatically enroll all non-participating employees once a year, even if the employees opted out during prior automatic enrollment cycle. Also, employers should set a high enough automatic enrollment percentage to make a difference. For example, using a 1% rate for new employees does not give you much leverage. A 3% automatic enrollment level for all employees not participating will provide better results.
    • Institute automatic increases. One of the drawbacks to automatic enrollment done by itself is that employees who are automatically enrolled actually have a lower contribution rate than those who voluntarily enroll. This is because the most-used automatic enrollment level is 3% of pay, where the average voluntary enrollment percentage is 5.4% of pay. Instituting automatic increases of, for example, 1% per year until the participant is contributing at 10% of pay avoids this issue. Some employees will opt out, but the vast majority will stay at the higher contribution level.
    • Implement a safe harbor 401(k) plan. To eliminate testing problems, employers often implement a safe harbor provision. If the employer contributes a certain level of contribution which meets a vesting requirement, the testing does not need to be performed. Below is a recap of available safe harbor contributions.

      Type of Safe Harbor
      Required Contributions
      Vesting Requirement
      Safe Harbor Match
      (given to those who defer into the plan)
      100% of first 3% of pay deferred + 50% of next 2% of pay deferred 100% immediate
      Safe harbor Nonelective
      (given to anyone eligible, even if not deferring into the plan)
      3% of pay 100% immediate
      Qualified Automatic Contribution Arrangement (QACA)
      (two types of contributions)
      Employees must be automatically enrolled into plan at 3% of pay level or higher & must be escalated to 6%

      Employer contributions must be:

      1.) Match – 100% of first 1% of pay deferred + 50% of next 5% of pay deferred, a maximum match of 3.5% of pay; or

      2.) Nonelective – 3% of pay for all eligible
      100% vested after 2 years of service
    • Make your match go further. Just changing your matching structure without increasing the dollars involved can drive behavior. For example, if your current match is 50% of the first 4% of pay contributed, you will probably find a large number of non-highly-compensated employees contributing at the 4% level. If you were to change that match structure to 25% of the first 8% of pay contributed and couple that move with effective education, your plan would most likely see an immediate migration toward the 8% of pay contribution level.

      If you do decide to make your match richer, it's best to do it in a way that incents desired contribution behavior. Retirement plan experts say that employees need to save at least 15% of pay for their entire working careers (source: EBRI). So, in an ideal world, a great matching scenario might be 50% of contribution to 10% of pay to bring the employee to that desired 15% overall contribution amount. However, economic conditions play a big part in whether such an approach is feasible.
    • Build a case for retirement savings. Many employees do not save for retirement because they truly do not understand how important it is to do so, and how dire the future might be if they do not. Placing retirement savings in context is essential but rarely done well. Also, helping employees understand how the little choices they make every day can have huge impacts over time can strengthen the message.
    • Target non-highly-compensated employees for a participation campaign. The reason a plan fails testing is that non-highly-compensated employees are not participating adequately. Targeted, personalized communication with easy enrollment cards, small prizes and incentives (they must be kept de minimis to avoid ERISA issues), mandatory enrollment meetings on paid time, and tools that teach employees how to save can all help with this effort.
    • Keep it simple. Studies show that a large array of investment choices overwhelms participants and that participation actually drops off as the number of investment choices increases. For the vast majority of participants, automatically enrolling them, automatically increasing contributions, and automatically using a target date fund and/or risk-based portfolio provides a way for them to "set it and forget it" with little or no effort needed on their part. This approach will most likely have the best impact on participation.


Reminder — Business Associate Agreements

In a previous article, we informed you about new requirements for Business Associate Agreements (BAA). Covered entities and business associates should have modified their BAAs for business associates, agents and subcontractors by September 23, 2013. There is a transition period for BAAs that were in place as of January 25, 2013 and are not renewed or modified between March 26, 2013 and September 23, 2013. Entities have until the earlier of the date the BAA is renewed or modified, or September 22, 2014 to amend the BAA.


New DOL Requirements for Finding Lost Participants

The Department of Labor (DOL) provided guidance to fiduciaries to fulfill their obligation to pay retirement benefits to missing participants when a retirement plan is terminated. These new rules apply to defined contribution plans (401(k), profit sharing or money purchase plans). Finding missing participants can be daunting. Sometimes employers can never locate a former employee. When a retirement plan is terminated, the assets must be distributed as soon as administratively feasible so something must be done with the missing participants' accounts. According to the new guidance, fiduciaries will fulfill their obligations if they meet the following two criteria:

  • Search for missing participants – the employer may use the following methods:
    • Certified mail – a fiduciary or provider should send a notice via certified mail informing the participant about retirement accounts. The DOL has a model notice but you are not required to use it.
    • Check related plan and employer records – fiduciaries should ask employers or third-party providers for contact information to locate a former employee. For example, a group health plan provider may have a more recent address for a missing participant. If there are privacy concerns, the fiduciary can ask that the employer or provider forward a letter to the participant or beneficiary asking them to contact the fiduciary or provider performing the search.
    • Check with the designated beneficiary – if the participant completed a beneficiary form including an address for the beneficiary, a notice should be sent to the beneficiary asking them to have the participant contact the fiduciary or search provider.
    • Use internet search tools – fiduciaries or service providers should perform online searches for missing participants. These tools include search engines, public record databases (such as those for licenses, mortgages, real estate taxes, etc.), obituaries and social media.
    • Other search steps as deemed necessary based on the account balance size – if the above search methods do not work, the fiduciary will need to evaluate the cost to continue to search and the amount of the account balance and decide whether additional steps should be taken to locate a missing participant. Facts and circumstances should be considered in making this decision and the employer or provider should document these decisions. Additional steps may include internet search tools, commercial locator services, credit reporting agencies, information brokers, investigation databases, etc.
  • Distribute account to individual retirement plan – if the search effort does not produce a missing participant, the plan may transfer the account balance directly into an IRA in the name of the missing participant. This includes accounts in excess of $5,000. This will be a tax-free rollover so the participant does not have a tax liability when the money moves from the retirement plan to the IRA. Fiduciaries must exercise due diligence in selecting an IRA trustee or custodian as well the initial investment in the IRA.

If the fiduciary was unable to locate the missing participant and is unable to distribute the account to an IRA because they cannot locate a provider to take the money or there is some other compelling reason based on facts and circumstances, then there are two alternatives to pay out the money –

  • open an interest-bearing federally insured bank account in the name of the missing participant or

  • transfer the account balance to a state unclaimed property fund.

The DOL specifically stated in the guidance that an employer should not send 100% of the account balance to the IRS as tax withholding.

If these rules are followed during a plan termination, fiduciaries can feel confident that they have met their fiduciary obligation with respect to missing participants. Documenting the searches performed and the IRA rollover is key so that fiduciaries can prove upon audit that the process they followed meets the DOL's standards.


Update on Same-Sex Marriages and Retirement Plan Issues

In June, 2013, the Supreme Court ruled that the definition of spouse under the Defense of Marriage Act (DOMA) is unconstitutional. Earlier this year, the IRS has provided additional guidance and clarifies the following:

  • Any qualified retirement plan rules that apply to "spouses" must apply to same-sex spouses.
  • Same-sex spouses should be recognized as spouses for retirement plan purposes as of June 26, 2013. According to the IRS, individuals of the same sex will be considered to be lawfully married as long as they are married in a state whose laws authorize the marriage of two individuals of the same sex, even if the spouses currently live in a state that does not recognize same-sex marriage. There was a period of time where it was uncertain whether the participant must also be domiciled in a state that recognized same-sex marriages so if a plan applied this rule between 6/26/2013 and 9/16/2013, the plan will remain in compliance.
  • A plan may recognize same-sex spouses as spouses before June 26, 2013, however, doing so may trigger administration issues that are difficult to implement and may create unintended consequences, e.g. a retroactive compliance failure may occur because a same-sex spouse was not provided a right to a qualified joint and survivor annuity (or waiver of). Most plan sponsors will more than likely apply the court ruling as of June 26, 2013 and prospectively.
  • Plan documents must contain a definition of spouse that is consistent with the outcome of the Court ruling. Plan sponsors should review their documents to determine if an amendment is required. If one is required, an amendment should be signed no later than a normal provisional plan change amendment deadline or for most plans, December 31, 2014. The IRS confirmed that the spouse definition in a safe harbor 401(k) plan may be amended during the plan year. For 403(b) plans, the deadline is not yet determined.

Plan sponsors should review their administrative procedures to ensure that same-sex spouses are afforded the same retirement plan rights as opposite-sex spouses.