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How to Simplify Your 401k Admin with a Cycle 3 Plan Restatement

Eric Droblyen

December 29, 2022


As a business owner, you must operate your 401(k) plan according to the terms of a written plan document. Most plans use an IRS preapproved document for this purpose. All preapproved documents must be fully rewritten (or restated) every six years to reflect recent law changes. The last 6-year restatement cycle was called “PPA” after the Pension Protection Act. A new cycle - called "Cycle 3" - opened last year. Between August 1, 2020 and July 31, 2022, all pre-approved 401(k) plans must be restated from a PPA to a Cycle 3 plan document. That means now.

In my view, there is no better time for employers to simplify the administration of their 401(k) plan than restatement time.  The reason - you can wrap discretionary plan amendments into your restatement for no additional fees. Here are some simplifications to consider (when applicable).

High 401(k) Fees

Plan Eligibility

The eligibility provisions of your 401(k) plan document define the age and/or service requirements that employees must meet join your plan and the employee classes to be excluded from plan participation altogether (if any).

Some simplifications to consider include:

  • Remove hours requirement – 401(k) plans have two options for crediting employee service for plan eligibility purposes – the elapsed time or counting hours method. Only time of employment is considered under the elapsed time method, while hours of service must also be considered under the counting hours method.
    • If you are tired of tracking hours to determine when your employees are eligible to join your plan, you should consider a switch from the counting hours method to elapsed time.
    • Removing an hours requirement can also help you sidestep the SECURE Act’s “long-term, part-time employee” rule. Under this new rule, 401(k) plans must allow employees that do not meet the plan’s normal service requirements to make elective deferrals once they complete at least 500 hours of service in three consecutive twelve-month periods. Hours of service before 2021 do not count.
  • Remove dual eligibility – Some 401(k) plans have “dual” eligibility - in other words, they have stricter eligibility requirements for employer contributions than employee contributions. Because dual eligibility can subject a safe harbor plan to top heavy and ACP testing, the approach is most often employed by “traditional” (non-safe harbor) plans. Dual eligibility usually means more eligibility determinations for you each year.
    • If you don’t need dual eligibility to help pass nondiscrimination testing or lower your contribution expenses, you should consider homogenizing your plan’s eligibility requirements (i.e., make them the same) for all contributions.
    • Homogenizing your plan’s eligibility requirements can be a no-brainer if your 401(k) plan is top heavy - because top heavy plans must make a 3% contribution to non-key employees who met the most liberal service requirement.

Plan Compensation

Your 401(k) plan document must define the compensation to be used when allocating contributions to plan participants. This definition is called plan compensation. When defining plan compensation, employers have three options for a starting point. Most choose Form W-2, Box 1 wages that have been grossed up by elective deferrals.

You can exclude forms of compensation from plan compensation, but these exclusions cannot discriminate against non-Highly-Compensated Employees (HCEs). Most employers exclude no more than the “safe harbor” exclusions under IRC Section 414(s) like pre-entry pay or fringe benefits.

Some simplifications to consider include:

  • Remove pre-entry pay exclusion – One of the most common plan compensation exclusions is “pre-entry” pay – which is pay earned by employees before they join your plan. Calculating pre-entry pay can be frustrating.
    • If you don’t mind allocating contributions to plan participants based on their full-year compensation – instead of the portion they earned after joining your plan - you should consider removing the exclusion to avoid the need to calculate pre-entry pay.
  • Remove non-safe harbor exclusions – Excluding non-safe harbor forms of compensation – like bonuses or overtime - will subject your plan compensation to a special 414(s) test. It’s illegal to allocate safe harbor or “permitted disparity” profit sharing contributions to participants or test any contribution for nondiscrimination using compensation that cannot pass this test.
    • If your plan compensation excludes non-safe harbor forms of compensation, you should consider removing them. Correcting contribution allocations or testing based on plan compensation that failed the 414(s) test can be expensive and time-consuming.

Plan Contributions

Your 401(k) plan can permit employee and employer contributions. Employee contributions include pre-tax and Roth elective deferrals, while employer contributions include safe harbor, matching and profit sharing. All contributions must be allocated to participants pursuant to a formula in your plan document.

Some simplifications to consider include:

  • Add a safe harbor contribution – 401(k) plans can automatically pass the ADP/ACPand top heavy nondiscrimination tests by making a safe harbor contribution to plan participants.
    • If your plan has trouble passing the ADP/ACPand/or top heavy nondiscrimination tests, you should consider adding a safe harbor contribution to your plan. Doing so will allow your plan’s Highly-Compensated Employees (HCEs) to make elective deferrals up to the legal limit ($26,000 for 2021, including catch-ups) with no risk of corrective refunds, while costing you about the same as a top heavy minimum contribution.
  • Make a new comparability contribution more flexible - New comparabilityis the most flexible type of profit sharing contribution. It allows you to allocate a different contribution rate to various employee groups – or even individuals. Most employers use this flexibility to allocate larger contribution rates to business owners or other Highly-Compensated Employees (HCEs).
    • If your plan includes a new comparabilityprofit sharing contribution, I recommend you consider a “one group per participant” formula with no allocation conditions (i.e., 1,000 hours requirement or last day rule). This combination will make your new comparability contribution as flexible as possible – making it easier for you to meet your contribution goals for the lowest cost.

Plan Distributions and Loans

A 401(k) account withdrawal is called a distribution. In general, 401(k) plans must permit participant distributions following a separation from service or death. They may also allow participants to take in-service distributions while still employed. To give participants even greater access to their account, a plan can offer a participant loan feature.

Some simplifications to consider include:

  • Remove optional forms of distribution – most 401(k) plans are only obligated to offer a lump sum distribution option following a separation from service. Other forms of distribution – including installments, partial payments, or annuities – are optional.
    • In my experience, optional forms of distribution are more popular with plan providers than plan participants. If you plan includes them, consider their removal if participants do not use them.
  • Increase force-out limit - 401(k) plans can force-out (i.e., involuntarily distribute) small account balances attributable to terminated participants. Account balances between $1,000 and $5,000 must be rolled over into an IRA for the benefit of the participant, while amounts below $1,000 can be distributed as cash.
    • Terminated participants can be difficult to reach. To mitigate this issue, consider raising your plan’s force-out threshold to the legal limit ($5,000). Just be sure you have a process in place to force out terminated participants routinely.
  • Limit participant loans – 401(k) loans are often very popular with employees, but the feature can add administrative complexity for you.
    • If your plan includes a participant loan feature, consider simplifying its administration by reducing the maximum number of outstanding loans to one.

Maximize your Restatement Fee!

401(k) providers can charge dramatically different fees for Cycle 3 restatements – from $500 to $2,000 in my experience. Using your restatement as an opportunity to simplify your plan’s annual administration can help soften the blow.

For additional questions about your 401(k) plan’s Cycle 3 restatement, contact your 401(k) provider.

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