Switching jobs and unsure what to do with your 401(k) account? If you’d like to keep growing your retirement savings on a tax-deferred basis, you can leave your account in your former employer’s plan or roll it into your new employer’s 401(k) plan or an Individual Retirement Account (IRA). Rolling your account can seem like the obvious choice, but in some cases, leaving it could grow your retirement savings faster.
Owners of a partnership or sole proprietorship (or an LLC taxed as either) are considered “self-employed individuals” for 401(k) plan purposes. 401(k) plans must allocate and test the annual contributions made to self-employed individuals using a special definition of plan compensation called earned income. When applicable, earned income is calculated by the plan’s Third-Party Administrator (TPA) based on information prepared by the employer’s Certified Public Accountant (CPA). The CPA, in turn, will use the TPA's calculation to finalize the employer’s year-end tax returns.
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When two or more companies with common ownership meet the IRS’ controlled group definition, they are considered a single employer for 401(k) plan purposes. 401(k) plans must often benefit the employees of all controlled group members to pass the IRC section 410(b) “coverage” test annually. Put differently - overlooking a member can often mean a failed coverage test. Steep IRS penalties - including plan disqualification - are possible when a failure goes uncorrected for years. A basic understanding of the controlled group rules can help employers avoid this trouble.
There are few industries where the phrase “you get what you pay for” is less applicable than the 401(k) industry. Equally competent 401(k) providers can charge dramatically different fees for comparable administration services and investments. This variability is a big problem for employers – who have a fiduciary responsibility to protect the interests of plan participants by paying only “reasonable” 401(k) fees. Employers that fail to meet their responsibility can be personally liable for restoring participant losses due to excessive fees.
Employers have a fiduciary responsibility to ensure the fees paid by their 401(k) plan are “reasonable” – so excessive fees do not reduce the investment returns of plan participants needlessly. To do that job, employers should ”benchmark” their 401(k) fees periodically by comparing them to industry averages and/or the fees charged by competing 401(k) providers. Sounds straightforward, but this information is hard to find and often harder to compare on an apples-to apples basis.
401(k) plans must define a 12-month “plan year” for annual administration purposes. Most plans choose a calendar year for administrative ease. A new plan can specify a period that’s shorter than a full 12-months for its initial plan year by choosing a mid-year effective date. However, establishing a short plan year with a mid-year effective date is often a bad idea. Most plans are better off making their effective date retroactive to the first day of the normal plan year - January 1 in the case of a calendar-based plan – to establish a 12-month initial plan year.