The Frugal Fiduciary Small Business 401(k) Blog
Get the latest industry news, deadlines and tips you need to know to help tackle your fiduciary responsibility needs.
Safe harbor 401(k) plans are the most popular type of 401(k) sponsored by small businesses today. They can automatically pass Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and top heavy testing, which helps business owners maximize personal contributions. To achieve safe harbor status, a business must meet certain employer contributions and participant disclosure requirements. For many owners, that trade-off is well worth the cost. Here’s why:
Inappropriate investment selection is one of the top three reasons why 401(k) fiduciaries are sued today. In my experience, employers can easily avoid these lawsuits by having a clear understanding of their investment-related 401(k) fiduciary responsibilities. These responsibilities are surprisingly basic. They boil down to selecting enough “prudent” investments to permit any plan participant to sufficiently diversify their account – to minimize their risk of unrecoverable losses. A prudent investment is simply one that meets its investment objective for reasonable fees. I’ve never seen a leading index fund from providers such as Vanguard, Fidelity, or Schwab fail to fit this bill. For that reason, I consider these funds to be indisputably prudent 401(k) investments.
To meet retirement goals as affordably as possible, 401(k) participants must do three basic things – save early and often, invest appropriately, and keep account fees to a minimum. Investing appropriately involves constructing - and maintaining – a 401(k) investment portfolio that balances growth potential with the risk of losses.Striking this balance is important. Otherwise, a 401(k) participant could miss out on gains by investing too conservatively when young or sustain unrecoverable losses by investing too aggressively when near retirement.
There are few industries where the phrase “you get what you pay for” is less applicable than the 401(k) industry. That’s because equally competent 401(k) providers can charge dramatically different fees for comparable administration services and investments. This variability is a big problem for business owners – who have a fiduciary responsibility to protect the interests of their 401(k) participants by paying only “reasonable” fees from plan assets. If an owner fails to meet their responsibility, they can be personally liable for restoring participant losses due to excessive fee payments.
To meet IRS qualification requirements, 401(k) plans must pass nondiscrimination testing annually to ensure plan contributions do not disproportionately benefit Highly-Compensated Employees (HCEs) or exceed legal limits. While most employers hire a professional third-party administrator (TPA) to complete this work, all employers should understand the deadlines that apply to the process – which generally relate to failed testing and contribution funding. This basic knowledge can help avoid the often painful consequences of late testing – including missed tax deductions, IRS penalties, and plan disqualification.
On December 20, 2019, the President signed the Further Consolidated Appropriations Act, 2020 into law. This year-end spending package included the most extensive retirement plan legislation in over a decade - the Setting Every Community Up for Retirement Enhancement (SECURE) Act. After the SECURE Act was passed by the House, I judged the bill a mixed bag of good, bad, and ugly – the good representing welcome reform, the bad representing undue complexity, and the ugly representing handouts to the financial industry. That view has not changed now that the bill is law.