By William H. Black Jr.
Fall is here, and before you know it, year end. This is the time when self-storage owners wrap up their fiscal year, think about ways to minimize the tax bite, and arrange their business affairs for the upcoming year.
One business area they should definitely be thinking about is their company 401(k) plan. A well-executed plan can be a tool for recruiting and retaining talented employees, but it can also provide several tax benefits for small-business owners.
You may have enacted your 401(k) plan several years ago. Since then, there have been legislative changes. In addition, your employee demographics have likely changed or maybe even your objectives. Its time to review your 401(k) plan to ensure its still providing your business and employees with the maximum benefits.
The Review
There are many reasons to conduct a compliance review of your 401(k) plan, but there's one thing that can be virtually guaranteed: If your plan was implemented by a payroll or mutual-fund company or is any form of bundled plan (also known as a cookie-cutter plan), its likely that a custom design can save you tens of thousands of dollars in employee costs. It can also save you a good deal of effort. Many bundled plans require the sponsor to prepare his own Form 5500 and other administrative duties, while a full-service administration firm performs all those tasks on his behalf.
The custom design generally beats the cookie cutter every time, and by a significant margin. But there are other reasons to review your 401(k) plan. ERISA, the Employee Retirement Income Security Act of 1974, requires employers to meet certain requirements. Ignoring or neglecting the rules can lead to plan disqualification, fines and other unpleasantness. The most common areas of trouble include:
Plan design. The first thing to realize about a 401(k) plan is the tax benefits. Contributions are income-tax deductible and growth is tax-deferred. In addition, plan assets are protected from the claim of judgment creditors. Ones account balance is, generally speaking, eligible for an IRA rollover when one separates from the plan.
While those benefits are favorable for the business owner, the task is to determine if the plan has maximized those benefits for the plans sponsor. No one is advocating taking away from participating employees, but if there's a way to amend the plan to put away more for the favored group without increasing costs for others, would it not make sense to do so? There are many ways to do this, but only through a custom design.
Fees. Fees must be reasonable. Though there's no specific definition of the term, one way to measure is to compare the fees your plan pays to the actual cost of the funds themselves if purchased retailin other words, a benchmark. Is the difference reasonable for the services provided?
Under the new ERISA Regulation 404(a)(5), fees and costs must be disclosed to all participants. Most investment houses are sending the disclosures to the plan sponsor, requiring the sponsor to make the disclosure to participants. This is new and everyone must comply.
Employee meetings. Is your plan administrators representative meeting with participants at least semi-annually (preferably quarterly) to revisit the benefits and merits and investment performance?
Investment offerings. The 401(k) plan sponsor is responsible for the fund lineup, or how the offerings compare to benchmarks. Do the investment choices get rearranged when laggards are discovered? How were the funds chosen? What are the default options? Are the offerings diverse?
Highly compensated employees (HCE). This is defined as those who made more than $115,000 last year, those who own more than 5 percent of the business or, under rules of attribution, spouses and lineal descendants and ascendants of HCEs. Many believe there are limitations on how much HCEs can defer. Ever hear, I dont understand why I send contributions to my 401(k) plan and they keep sending it back? The plans design is likely a cookie-cutter not set up to enable the HCEs to maximize the tax benefits available.
Eligible employees. The plans document defines whos eligible. If your plan does not offer automatic enrollment, make sure you retain evidence of all employee notifications of eligibility to enroll.
Notices. Every participant must receive a Summary Plan Description (SPD) when entering the plan. This is a plain English explanation of the plan. Annually thereafter, a Summary Annual Report (SAR) is necessary.
EIN (tax identification number). Every plan is a trust, a tax-exempt trust. Its also a separate legal entity. Do you have a separate EIN for the plan? We find frequently that sponsors using bundled plans have not obtained this EIN, and that is a mistake. Think about it: When a participant leaves a plan, hes provided with a 1099-R. The payors EIN must be shown on the form, and the payor is the plan. This is but one example.
Documentation. The sponsor has the duty to show it acted reasonably and prudently on behalf of the plan participants. Therefore, document it. Examples of things to document:
- How and when plan investment choices were reviewed and compared to the benchmarks
- How and when laggards were removed and replaced with similar funds with better track records
- How fees of investment choices were reviewed and date of review
- How investment choices were in fact chosen, what criterion and what measure was used
Plan contributions. Plans with less than 100 participants must have salary deferrals transferred to the plan no later than the seventh day following the day of withholding. The plan must have a fiduciary responsible for ensuring monies are successfully transferred.
Not only should your 401(k) plan be reviewed for disclosure and fiduciary compliance under new regulations, you should revisit its design and structure to ensure its benefits are being maximized for all parties involved.
Note: This discussion is not intended as tax advice. The determination of how the tax laws affect a taxpayer is dependent on the taxpayers particular situation. A taxpayer may be affected by exceptions to the general rules and other laws not discussed here. Taxpayers are encouraged to seek help from a competent tax professional for advice about the proper application of the laws to his situation.
William H. Black Jr. has been in the pension-administration business for 34 years. His firm, Pension Services Inc., administers defined contribution and benefit plans and employs an ERISA attorney, an enrolled actuary and a complete clerical staff. He is a speaker and author for several industry journals\ and has appeared on financial radio shows to discuss retirement and financial matters. To reach him, e-mail bill@pensionsite.org .
