<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=200924570504223&amp;ev=PageView&amp;noscript=1">

Small businesses can have dramatically different goals for their 401(k) plan. While some want to maximize contributions for business owners, others want to incentivize rank-and-file contributions.  The process of matching 401(k) goals to available options is called 401(k) plan design.

If you’re a business owner, you want to understand your 401(k) plan design options because the consequences of making poor choices can be severe – including thousands of dollars in unnecessary plan expenses, poor employee participation, or annual plan testing failures.

401(k) plan design can seem intimidating at first blush, but it doesn’t need to be.  You only need to define six major 401(k) features - eligibility, compensation, contributions, vesting, distributions and loans.  Better still a quality 401(k) provider will take the time to guide you through the process – answering any questions you might have about your options and helping you pick the best ones based on your company’s 401(k) goals and budget.

Below is a checklist that outlines the most common options for the six 401(k) features that must be defined during the plan design process.  When you understand these options, you’ll be ready for a productive plan design conversation with your 401(k) provider.  Want to know the most popular options chosen by Employee Fiduciary clients?  Check out our plan design study.

Before you start...

Before you start the 401(k) plan design process, you should be clear whether or not your company is part of a Controlled Group (CG) or Affiliated Service Group (ASG).  That’s because CGs and ASGs are considered a single employer for 401(k) purposes – which means your 401(k) plan may need to cover all CG or ASG members to satisfy IRS qualification requirements – specially, the IRC section 410(b) “coverage” test.  If this test fails in any year, your 401(k) plan can be disqualified.

Do not fail coverage testing because you do not know your company’s CG or ASG status. If you have trouble making a CG or ASG determination, consult your 401(k) provider or legal counsel. 


Download this checklist as a PDF

401(k) Plan Design Checklist PDF


 A. General Information

Plan type and plan features are elected in this section. A 401(k)/profit sharing plan can be sponsored by private or tax-exempt organizations. A 403(b) plan can be sponsored by tax-exempt or public education organizations. A 457(b) plan can be sponsored by tax-exempt or certain government organizations.

If a plan feature is selected here, the applicable section of the Plan Specifications Form must also be completed. For example, if safe harbor is elected, the safe harbor section of the Plan Specifications Form must also be completed.

Plan Effective Date: ______________   Plan Year-End: ______________

Plan Effective Date will affect plan compensation for the 1st plan year. For example: if a calendar year plan selects a January 1, 2018 effective date, contributions will be calculated based on full 2018 compensation. If a mid-year date is elected, contributions will be based on pro-rated compensation.

Plan Features:

❑ Pre-tax 401(k)
❑ Roth 401(k)
❑ Safe Harbor
❑ Match
❑ Profit Sharing

 

B. 401(k) Eligibility

Employers may allow new employees to enter the plan immediately, or they may impose minimum service or age requirements. They may also limit plan enrollment dates to monthly, quarterly, or semiannual windows. Certain employee classes can be excluded from a 401(k) plan altogether as long as annual IRS coverage testing is passed.

The law permits you to exclude union and nonresident alien employees from your plan without issue. You can exclude other classes of employees, but only if these classes do not exceed 30% of your workforce.

401k-plan-eligibility

Will plan waive above-selected eligibility provisions for ALL employees employed on a particular date?

❑ No   ❑ Yes
 

       If Yes, enter special effective date: _____________________

Will an employee have to work 1,000 hours in order to be credited with one year of eligibility service?

❑ No   ❑ Yes
 

Excluded Employees:

❑ None   ❑ Union Employees   ❑ Nonresident Aliens   ❑ Leased Employees   ❑ Other
 

Download this checklist as a PDF

401(k) Plan Design Checklist PDF


 C. Compensation

The law permits you to exclude certain types of compensation for plan purposes without issue, including compensation earned prior to plan entry and fringe benefits. You can exclude other types of compensation (bonuses, overtime, etc., but these exclusions will subject the compensation definition to special annual testing (additional fees apply).

Plan compensation shall mean wages and other payments for which the employer must file a Form W-2, except:

❑ Fringe Benefits
❑ Post-Severance(1)
❑ Other(2)

(1) ”Post-severance” compensation is unused sick, vacation, or other leave paid within the 2½ months following date of termination.

(2) Safe harbor 401(k) plans and plans containing an “integrated” profit sharing formula cannot elect this option. Other plans may be subject to special “IRC 414(s)” testing annually to test plan compensation definition for nondiscrimination (additional fees apply).

For an employee’s first year of participation, this compensation shall be recognized from:

❑ The first day of the plan year
❑ The day the employee is eligible to enter the plan

 

D. Employee Contributions

401(k) deferrals are pre-tax contributions made to a plan at the election of an employee, in lieu of receiving such amounts as cash compensation. Roth deferrals are similar to 401(k) deferrals, only they are contributed by employees on an after-tax basis.

An automatic enrollment feature allows an employer to enroll employees in a 401(k) plan without the employees’ affirmative election, as long as the employees have the right to “opt out” of contributing or change the amount of automatic deferral. Adding an automatic enrollment feature to a 401(k) plan generally increases the level of employee participation in the plan.

A Qualified Automatic Contribution Arrangement (QACA) is a special type of automatic enrollment feature that also satisfies safe harbor contribution requirements (see Safe Harbor Contributions).

401(k) Deferral limit is ______% of included compensation. If percentage is not indicated, 401(k) deferrals will be limited by the IRS limitations only. Limits also applies to Roth Deferrals (if applicable).

An employee may start or modify a 401(k) deferral election on the following frequency:

❑ Per Payroll
❑ Monthly
❑ Quarterly
❑ Semi-annually
 

Will plan provide for automatic enrollment?

❑ No, if no skip to section E     
❑ Yes
 

Automatic enrollment default percentage: _____% (minimum 3%)

Is feature to qualify as a QACA? ❑ No ❑ Yes

What is default escalation schedule: _______________________________

What is vesting schedule? ❑ 100% immediate ❑ 2-year cliff

 E. Safe Harbor Contributions

A safe harbor 401(k) plan is a type of 401(k) that automatically satisfies ADP/ACP testing requirements. A safe harbor 401(k) plan will also automatically satisfy top heavy minimum contribution requirements for a year in which the only contributions made to the plan are elective deferrals (pre-tax or Roth) and safe harbor contributions (i.e., no profit sharing contributions).

Eligible safe harbor contributions include:

  • 4% matching contribution
  • 3.5% matching contribution (QACA safe harbor plans only – see Employee Contributions section)
  • 3% non-elective contribution

These contributions are non-discretionary (required) contributions. They must be subject to 100% vesting and not be subject to any allocation conditions.

❑ Effective date of safe harbor feature:
❑ Plan Effective Date
❑ Date _______________
 

Safe harbor effective date will affect plan compensation for the 1st plan year. For example: if a calendar year plan selects a January 1, 2018 effective date, safe harbor contributions will be calculated based on full 2018 compensation. If a mid-year date is elected, safe harbor contributions will be based on pro-rated compensation.

Choose one of the two safe harbor contribution options below:

❑ 1) Safe Harbor Matching Contribution – choose only one of the three following options:

❑ Basic formula: 100% of applicable contributions up to the first 3% of Compensation, plus 50% of applicable contributions up to the next 2% of Compensation
 
❑ Enhanced Formula: ______% of applicable contributions up to ______% of Compensation
 
❑ QACA formula: 100% of applicable contributions up to the first 1% of Compensation, plus 50% of applicable contributions up to the next 5% of Compensation (QACA plans only)
 

The Safe Harbor matching contribution formula elected above is applied separately for each:

❑ Per Payroll
❑ Monthly
❑ Quarterly
❑ Annually
 

❑ 2) Safe Harbor Non-Elective Contribution – Minimum 3% of Compensation

 F. Matching Contributions

The plan may provide for a matching contribution based on the elective deferrals made by participants. The matching formula also may be discretionary, so that the employer will determine each year what the rate of match should be.

The following factors might be taken into consideration in designing a matching contribution formula: (1) whether the employer wants discretion in setting the amount each year, (2) whether the formula should be tiered (i.e., a different rate of match for different levels of elective deferrals), and (3) whether the amount of the match should be capped to a specific percentage of compensation or a specific dollar amount.

If the match is funded after the close of the year, the plan can require participants to satisfy certain allocation conditions in order to receive a contribution. For example, the plan can require participants to work a certain number of hours during the plan year (up to 1,000 hours) and/or be employed on the last day of the year.

The employer match will be:  ❑ Discretionary   ❑ Fixed (i.e., Required)

If fixed, describe match formula: _______% of 401(k) up to _______% of Compensation

Matching Contributions will be allocated to participant accounts at the following time(s):

❑ Per Payroll
❑ Monthly
❑ Quarterly
❑ Annually
 

Allocation restrictions (if applicable) – check either a or b and/or c:

❑ a. An employee must be employed with the employer on the last day of the plan year OR must have more than 500 hours of service for the plan year,
 
- OR -
 
❑ b. An employee must be credited with at least _________ hours of service (may not exceed 1,000) during the plan year
 
❑ c. An employee must be employed with the employer on the last day of the plan year
 

Note: If any of the above are checked, the employer match must be funded annually (not per payroll). If the plan is a safe harbor 401(k) plan any allocation restriction will subject ALL matching contributions to non-discrimination testing. 

G. Profit Sharing Contributions

A key advantage of a profit sharing contribution feature is that the employer can have flexibility in determining its annual contribution to the plan because of the ability to use a discretionary contribution formula. This way the employer is able to contribute more in years of high profitability, and to contribute less when business is not as good, without having to amend the plan’s contribution formula.

There are three principle profit sharing allocation formulas:

  • Pro rata – allocates a uniform contribution percentage amongst participants
  • Integrated – provides a greater allocation on compensation earned in excess of the “integration level” (usually the Social Security taxable wage base)
  • New Comparability – permits different allocation rates based on employee class assuming nondiscrimination testing is passed

If the profit sharing is funded after the close of the year, the plan can require participants to satisfy certain allocation conditions in order to receive a contribution. For example, the plan can require participants to work a certain number of hours during the plan year (up to 1,000 hours) and/or be employed on the last day of the year.

The Profit Sharing contribution will be: ❑ Discretionary   ❑ Fixed (i.e. Required)

The Profit Sharing formula will be:

❑ Pro Rata
❑ Integrated (integration level will be _____________% of SSA Taxable Wage Base)
❑ New Comparability – one group per participant (additional fees apply)
 

Profit Sharing Contributions will be allocated to participant accounts at the following time(s):

❑ Per Payroll
❑ Monthly
❑ Quarterly
❑ Annually
 

Allocation restrictions (if applicable) – check either a or b and/or c:

❑ a. An employee must be employed with the employer on the last day of the plan year OR must have more than 500 hours of service for the plan year.
 
- OR -
 
❑ b. An employee must be credited with at least _________ hours of service (may not exceed 1,000) during the plan year
 
❑ c. An employee must be employed with the employer on the last day of the plan year
 

Note: If any of the above are checked, the Profit Sharing must be funded annually (not per payroll). If the plan is a safe harbor 401(k) plan, no restrictions on discretionary match should apply.

 H. Retirement Age

At normal retirement age, participant accounts become immediately 100% vested. The maximum retirement age allowed by law is the later of 1) age 65 or 2) 5th anniversary of plan participation. The most commonly used retirement age is 65.

The plan’s Normal Retirement Age (NRA) will be:

❑ Age 65
❑ Age______
❑ Age ______ and ______ years of participation

 


Download this checklist as a PDF

401(k) Plan Design Checklist PDF


I. Vesting

401(k) and most safe harbor contributions must always be 100% immediately vested. Other contributions may be subject to a vesting schedule. When a participant terminates, they are only entitled to the vested portion of their account balance. Any unvested portion of their account must be forfeited to the plan. The plan can use these forfeitures to pay plan expenses or reduce future employer contributions. Generally, employers with transient work force favor lengthier vesting schedules in order to use forfeitures.

employer-contribution-vesting-schedules

Will the following service be excluded for vesting purposes?

Service before the original effective date of this plan   ❑ No   ❑ Yes
Years of service before the employee’s 18th birthday  ❑ No   ❑ Yes
 

Special 100% vesting – an employee’s vested percentage is increased to 100% if the employee:

❑ Dies
❑ Becomes disabled

 

J. Distributions

Often, plans will only permit the lump sum form of distribution when a participant separates from service and is entitled to a distribution. Under the lump sum option, a participant must take their entire vested account balance in a single distribution. Other distribution forms available include installment payments and partial payments.

The plan can permit a participant to take a distribution while still employed. These are called “in-service” distributions. These distributions can be available upon the attainment of a certain age (59 ½ or greater) or a “hardship” event. Eligible hardship events are defined by the law.

The plan may permit the involuntary cash-out of small account balances. Balances under $1,000 may be distributed in cash to the participant. Balances under $5,000 may be involuntarily rolled into an IRA for the benefit of the participant.

Will the lump sum form of distribution be the plan’s sole form of distribution?

❑ No   ❑ Yes
 
If no, optional forms available: ❑ Partial payments   ❑ Installments
 

Are Hardship withdrawals permitted?   ❑ No   ❑ Yes

Sources Available:   ❑ All (excludes safe harbor)   ❑ Employee contributions only
 

Are In-Service withdrawals permitted?   ❑ No   ❑ Yes

Age:   ❑ 59 ½   ❑ NRA   ❑ Age____
 
Sources Available:   ❑ All   ❑ Employee contributions only

 

K. Loans

The employer can allow or disallow loans. Loans are often very popular with employees but add administrative complexity for the employer, who often must sign off on loan requests.

Will Plan permit loans?   ❑ No   ❑ Yes

Maximum number of loans permitted?   ❑ One   ❑ Other ______

Loan repayments are deducted by payroll deduction and remitted along with payroll contributions.


Receive helpful information like this directly in your inbox by subscribing to The Frugal Fiduciary Small Business 401(k) Blog!