Frequently Asked Questions
Penelope 401(k) FAQ For Employers
Why should I consider starting a 401(k) plan for my company?
There are several reasons that you should consider starting a 401(k) plan today.
First, offering a 401(k) plan can be a valuable employee benefit that can help attract and maintain the best talent. Employees are often looking for a comprehensive benefits package, including retirement benefits, when considering job opportunities. Providing employees with a 401(k) plan can improve their financial wellness by helping them save for retirement, reducing their stress, and improving their overall well-being. Offering a 401(k) plan can be a competitive advantage for businesses in your industry, particularly if your competitors do not provide a similar retirement plan.
Additionally, your business can take advantage of tax benefits by offering a 401(k) plan. With the passing of Secure Act 2.0, businesses implementing a new 401(k) plan for their business for the first time can take advantage of significant tax benefits, including up to $16,500 in tax credits over the first three years of starting a new plan, plus an additional $500 for using plan auto-enrollment. These companies can also receive tax credits for employer contributions for the first five years of a new plan. Businesses with fewer than 50 employees can receive up to 100% of employer contributions back in tax credits for the first two years. These tax credits can help offset the costs of setting up and administering the plan. Employer contributions to the plan are tax-deductible, and employees can make pre-tax contributions, reducing their taxable income.
Considering all these advantages, it's easy to see why implementing a 401(k) plan for your business makes sense. This type of plan offers multiple tax incentives and investment options and helps employees ensure that they have gained enough wealth to enjoy their retirement.
Am I required to offer a 401(k) plan?
Although many employers offer a 401(k) plan to their workers these days, they are not required by law to do so. According to information from the U.S. Bureau of Labor Statistics, just 67% of private industry workers had access to a 401(k) plan in 2020.
Requirements for business owners regarding retirement plans are ever-changing, but at this time, employers do not have a legal obligation to offer a 401(k) plan to their workers. Still, 16 states have passed laws that require all business owners to either offer a plan to their eligible employees or participate in a state-sponsored plan, which is typically in the form of a Roth IRA. Check on your state’s specific requirements and deadlines to sign up, as you may be subject to penalties if you do not comply.
What is a Safe Harbor 401(k) plan?
A Safe Harbor 401(k) plan is a type of traditional 401(k) plan that includes specific features designed to make the plan more accessible and beneficial for employees. It’s called “safe harbor” because the employer is exempt from many testing requirements that apply to other types of plans.
These plans require employers to make specific contributions to employee accounts, which are either fully vested immediately or vested over a specific period of time.
What are the differences between a traditional 401(k) plan and a Safe Harbor plan?
Some of the key differences between a Safe Harbor 401(k) plan and a traditional 401(k) plan include:
Employer Contributions:
In a traditional 401(k) plan, employer contributions are typically optional, and there may be restrictions on how much employers can contribute. In a Safe Harbor 401(k) plan, employers are required to make contributions that meet specific criteria, such as matching or nonelective contributions. This requirement helps ensure that all employees benefit from the plan, regardless of their contribution levels.
Nondiscrimination Testing:
Traditional 401(k) plans require annual nondiscrimination testing to ensure that the plan benefits all employees fairly. Safe Harbor plans are exempt from these tests, making them an attractive option for employers who want to avoid the administrative burden and potential penalties associated with nondiscrimination testing.
Vesting Requirements:
Vesting is the process by which employees become entitled to their employer contributions over time. In a traditional 401(k) plan, employers can set their own vesting schedules, which can be as long as six years. Safe Harbor plans, however, require employer contributions to be fully vested immediately, which means employees are entitled to the contributions from the moment they are made.
Employee Contributions:
Employee contributions to a Safe Harbor 401(k) plan follow the same rules as those in a traditional 401(k) plan. Employees can make pre-tax contributions up to the annual limit set by the IRS and may also have the option to make after-tax or Roth contributions.
What other types of retirement plans are available to small business owners?
Simple 401(k)s:
Along with a traditional 401(k) plan, today’s employees may be offered plans such as the SIMPLE (Savings Incentive Match Plan for Employees) 401(k) plan for small businesses with 100 or fewer workers.
Solo 401(k)s:
Company owners that do not have any employees can still contribute to a 401(k) plan for themselves using a one-participant or a solo 401(k) plan. The eligibility for this type of plan is limited to the owner and their spouse (if their spouse works for the same business and receives pay from it).
SEP IRAs:
A Simplified Employee Pension (SEP) plan is an employer-sponsored arrangement for businesses that have more than one employee, and their employer contributions are made to IRAs (individual retirement account), established for each employee who is eligible. Many small businesses choose SEP IRAs since they are affordable and simple to manage.
Pooled Employer Plans:
Recently, PEPs have become more popular among small business owners. They make it possible for more than one small business owner to come together and jointly offer a reasonable and reliable 401(k) retirement plan to their workers.
Why should small businesses consider PEPs?
For millions of Americans employed by small businesses, who do have a way to save for retirement, a pooled employer plan could be a game changer. According to the U.S. Bureau of Labor Statistics, there are approximately 38 million private sector employees who lack access to an employer-sponsored retirement plan.
The Department of Labor hopes that the growing interest in PEPs will influence small business owners to offer this new and innovative option to their workers. PEPs help level the playing field by ensuring small businesses have the same benefits and advantages available to employees of larger companies. The SECURE Act of 2019 laid the groundwork for PEPs, while the subsequent SECURE 2.0 Act of 2022 further cemented their position.
Because PEPs involve multiple participating businesses, typically there are much lower administrative and record-keeping costs, in comparison to single employer retirement plans. Additionally, when dealing with traditional plans, companies must engage with record keepers, investment advisors, legal or tax advisors, trustees, custodians, auditors, and in some cases, actuaries. The costs incurred for these additional services can add up quickly. An investment advisor alone may cost a company as much as $50,000 to $250,000 per year based on the company’s size. When using a PEP, however, these services are all grouped together with one provider that offers economies of scale.
What is a plan document?
This is a legal instrument that establishes the major terms of the plan. It covers things like eligibility, types of contributions, vesting, benefit payment options and procedures, investment structure and compliance requirements. This is one of the things that is required to start a plan. The plan must be operated in accordance with its plan document provisions. The person who oversees the plan at your company usually holds the document and participants have the right to see it.
Our company has a plan administrator who seems to have a lot of responsibility for the plan. Is this the organization that is managing the plan?
It's an ERISA requirement that each plan has a plan administrator. The employer that sponsors the plan is usually named the plan administrator, but a specific corporate officer or a committee is usually appointed by the company to carry out these duties. The organization that manages the plan normally isn't the plan administrator because they don't want this responsibility.
The plan administrator has certain functions that are difficult for anyone outside the company to perform. One is distribution of the Summary Plan Description to all participants. The service provider usually prepares the SPD for distribution, but this organization isn't able to control the distribution to all eligible employees. The plan administrator can be fined for failing to perform duties such as this.
What is a required minimum distribution?
A required minimum distribution (RMD) is the minimum amount that a participant must distribute from their retirement account each year. These rules apply to all employer-sponsored plans, including 401(k) plans, and traditional IRAs and IRA-based plans such as SEPs and SIMPLE IRAs. Retirement plan participants that fail to take the correct RMD each year may face a penalty.
Who must receive minimum distributions from the plan and when?
Active employees (other than 5% owners) don't have to take any money out of the plan until after they leave the company– regardless of how old they are. Beginning in 2023, according to the SECURE 2.0 Act, employees must begin taking RMDs in the year that they turn age 73 (if they reach age 72 after December 31, 2022). The RMD amount is calculated based on the prior December 31 balance of the retirement plan divided by the life expectancy factor calculated by the IRS.
Still have questions about 401(k) plans?
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What is a 401(k) plan?
A 401(k) plan is a retirement savings program offered by employers that allows individuals to save money on taxes while building wealth for their future. When an employee “participates” in a 401(k) plan, it means that they agree to have a certain percentage of their paycheck paid into the plan. Savings into a 401(k) plan are known as “contributions”. One major benefit of a 401(k) is that employers can “match” employee savings, often up to a set percentage of that individual’s annual salary.
Is my money safe in a 401(k)?
The first piece is whether your account is safe. In general, 401(k) accounts are some of the most protected account types. One of the benefits of the 401(k) plan is that they are set up under the Employment Retirement Income Security Act. This means that plan sponsors (business owners) and administrators must meet more rigorous administrative requirements, but the benefit is that individual plan participants (employees) receive protection from the Department of Labor in cases of employer bankruptcy, civil lawsuits, or creditors making claims to employer assets.
The second piece relates to investment risk. Any type of investing involves a level of risk that your investments will lose value. You can reduce risk, but you can't eliminate it. Short of a few exceptions for certain types of investments held within a self-directed or solo 401(k) plan, money held in a 401(k) plan is not FDIC insured. The best way to reduce investment risk is by spreading your money across different types of investments, also known as “diversification”. Ask your employer and the company that runs your 401(k) to help you choose an investment mix that’s right for you.
What is the difference between a traditional 401(k) and a Roth 401(k)?
The difference between a traditional 401(k) and a Roth 401(k) plan is how they are taxed. Employers can decide whether to offer both options. Employees with the option to choose should consider which type of plan would be best for minimizing their total tax liability.
With a traditional 401(k) plan, an employee’s contributions are taken out of their paycheck before income taxes are withheld. This is what the IRS means by “pre-tax”. The employee benefits because the amount contributed is reported as a tax deduction (reduces the total amount of income that they need to pay taxes on that year), and taxes are not due to the IRS until they withdraw the money in retirement.
With a Roth 401(k) plan, an employee’s contributions are taken out of their paycheck after income taxes are withheld. This is what the IRS means by “after-tax”. While there is no tax deduction each year, when the money is withdrawn from the account, likely in retirement, no taxes are paid. The employee might benefit if they expect that they will be in a higher tax bracket after retirement than their current tax bracket.
How much money may I contribute to my 401(k)?
There are two limits that apply to all employees. The first is the maximum annual dollar limit that is $22,500 in 2023. Only employee contributions pulled “pre-tax”, or directly from employee paychecks, count toward this amount. After-tax contributions you make or contributions your employer makes are not counted toward this limit. The second contribution limit is the maximum contribution for all sources, which is $66,000 in 2023.
Employees over age 50 are allowed to contribute an additional $7,500 to their 401(k), known as a “catch-up contribution”. The maximum contribution including all sources, for employees age 50 or older, is $73,500 in 2023. Catch-up contributions are intended to help employees who are closer to retirement make up for prior years where they may not have been able to save as much.
Your contributions may not exceed 100% of pay. There also are special non-discrimination rules for 401(k)s that link the amount that highly compensated employees (HCEs) may contribute to the amount that the non-highly compensated employees (NHCEs) may contribute. It may be necessary to lower your contributions if you’re an HCE.
When can I start contributing to my 401(k) plan?
You can start contributing after the first entry date after you become eligible. It's up to the employer to determine how many entry dates there are and when they will occur. There may be only one entry date per year or each pay period may be an entry date. Some other possibilities are the first of each month or the first day of each quarter. Entry dates are chosen for administrative reasons. Newly eligible employees are often invited to attend a meeting that explains various plan details and investment options.
Each employer is allowed to set the rules for plan eligibility within acceptable legal limits. It's permissible to exclude employees who are not yet 21 and those who have not completed one year of service. However, employers aren't required to exclude these employees. If you aren’t sure whether you are eligible or not, ask your HR benefits team.
My plan requires a year of service before I’m eligible to join. What is a year of service?
There are two methods for determining years of service as defined in ERISA. The first is the hours of the service method. Typically, an employee must work at least 1,000 hours during the first 12 months of employment to receive credit for a year of service.
You have to satisfy this 1,000-hour requirement only once. You will always be eligible there-after, regardless of how many hours you work– but the number of hours you work may impact your eligibility to receive a contribution during a specific year and your vesting.
The other method for determining a year of service is known as the elapsed time method. Service is measured from your date of employment to your date of termination. Once you have been employed for 12 months, you receive credit for a year of service– regardless of how many hours you work.
What does it mean to be “vested”?
Vesting refers to owning the funds in your 401(k) plan. While employee contributions to the plan are always 100% owned by the employee, employer contributions may not have “immediate vesting”, which means those amounts are not owned by the employee yet and can be taken back if the employee leaves their job within a certain timeframe.
Employers can choose different criteria, guided by a few IRS rules. Employers can choose between “graded vesting” and “cliff vesting”. With graded vesting, employees gain additional percentage ownership to their employer’s contributions as their tenure at the company increases. With cliff vesting, the employee must wait a certain amount of time, then company contributions are owned all at once. The IRS mandates that an employee must be fully vested within 6 years with graded vesting and within 3 years with cliff vesting schedules.
When can I start withdrawing from my 401(k) savings?
The IRS intended the 401(k) plan to be a retirement savings account, and for that reason, there are certain rules that discourage younger savers from withdrawing money from their account. Employees younger than age 59 ½ must pay federal income tax, state income tax, and a 10% penalty on the amount withdrawn. There are exceptions to this rule depending on the employee’s situation, fully listed on the IRS website.
What’s an automatic employer contribution, and why would a company have one?
There are various types of employer contributions that eligible employees can receive, regardless of whether they contribute. The profit-sharing contribution is one type. Another is an automatic contribution– such as 3%. This type of contribution is paid to all eligible employees– usually as a percentage of pay. It can also be determined in some other manner such as a specific amount for every hour worked.
It's possible to have several different types of employer contributions within the same plan. For example, a plan with a profit-sharing or an automatic contribution may also include a matching contribution.
Note: An automatic employer contribution is also one of the design options with a safe harbor 401(k) plan.
I’ve heard about a lot of different 401(k) fees. How much does my 401(k) actually cost me?
How much you are paying in fees should influence how you invest, and if you are a business owner, who you decide to partner with as your 401(k) provider. It isn’t the only factor to consider, but it is an important one. Unfortunately, there isn’t any universal standard for disclosing fees. Investment funds include this information in the prospectus because they are required to do so by regulators. Other financial organizations may not be subject to a disclosure requirement. Where are these fees hidden? Information about fees may be buried in reports, showing up as deductions from your investment return.
Here are the 401(k)-related fees that you should be aware of as a participant:
- Investment management fees or expense ratios are the amount paid to the company that actually invests your savings. These fees are equal to a percentage of the amount you have invested and they vary by type of fund. They may range from 0.07% or less for an index fund to 1% or more for an active fund.
- Asset-based fees or AUM fees are charged by the organization that administers the 401(k) plan. This additional fee may be as small as 0.25% or as much as 1.5%.
- 12(b)1 fees or wrap fees are expenses that a fund may change to cover marketing expenses. For example, the 12(b)1 fee may be paid to a broker for sending business to the fund company.
- Finally, there are several types of transactional fees that employees should be aware of: rollover fees, loan fees, distribution fees, and more.
When you add these types of fees, your investment return in just one fund could be as little as 0.10% to as much as 3.2%! This is an extremely large spread and you should know where your expenses fall in this range.
Penelope offers low-cost Vanguard Target Date funds with an average expense ratio of 0.07%, and charges participants zero asset-based fees, zero 12(b)-1 fees, and zero transactional fees.