401(k) Plans For Small Businesses |
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Why 401(k) Plans?
Beginning in 2006, 401(k) plans may be established or amended to permit employees to designate some or all of their contributions (employee deferrals) as Roth contributions. These contributions are made on an after-tax basis, but distributions (including earnings) are tax-free (if certain conditions are met). This booklet highlights some of a 401(k) plan's advantages, some of your options and responsibilities as an employer operating a 401(k), and the differences among the types of 401(k) plans. For more information, a list of resources for you and for prospective 401(k) participants is included at the end of this booklet. Establishing A 401(k) Plan Initial Actions Adopt a written plan - Plans begin with a written document that serves as the foundation for day-to-day plan operations. If you have hired someone to help with your plan, that person likely will provide it. If not, consider obtaining assistance from a financial institution or retirement plan professional. In either case, you are bound by the terms of the plan document. Before beginning the plan document, however, you will need to decide on the type of 401(k) plan that is best for you – a traditional 401(k), a safe harbor 401(k), or a SIMPLE 401(k) plan. A traditional 401(k) plan offers the maximum flexibility of the three types of plans. Employers have discretion to make contributions on behalf of all participants, to match employees’ deferrals, or do both. These contributions can be subject to a vesting schedule (which provides that an employee’s right to employer contributions becomes nonforfeitable only after a period of time). In addition, a traditional 401(k) allows participants to make pre-tax contributions through payroll deductions. Annual testing ensures that benefits for rank and file employees are proportional to benefits for owners/managers. A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, must provide for employer contributions that are fully vested when made. However, the safe harbor 401(k) is not subject to many of the complex tax rules that are associated with a traditional 401(k) plan, including annual nondiscrimination testing. Both the traditional and safe harbor plans are for employers of any size and can be combined with other retirement plans. A SIMPLE 401(k) plan was created so that small businesses could have an effective cost-efficient way to offer retirement benefits to their employees. A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to the traditional plans. Similar to a safe harbor 401(k) plan, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5000 in compensation from the employer for the preceding calendar year. In addition, employees that are covered by a SIMPLE 401(k) plan may not receive any contributions or benefit accruals under any other plans of the employer. Once your have decided on the type of plan for your company, you will have flexibility in choosing some of the plan’s features -- such as which employees can contribute to the plan and how much. Other features written into the plan are required by law. For instance, the plan document must describe how certain key functions are carried out, such as how contributions are deposited in the plan. Arrange a trust fund for the plan’s assets - A plan’s assets must be held in trust to assure that assets are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments, and distributions to and from the 401(k) plan. Since the financial integrity of the plan depends on the trustee, this is one of the most important decisions you will make in establishing a 401(k) plan. If you set up your plan through insurance contracts, the contracts do not need to be held in trust. Develop a recordkeeping system - An accurate record keeping system helps track and properly attribute contributions, earnings and losses, plan investments, expenses, and benefit distributions in participants' accounts. If you have a contract administrator or financial institution assist in managing the plan, that entity typically will help in keeping the required records. In addition, a record keeping system will help you, your plan administrator, or financial provider prepare the plan’s annual return/report that must be filed with the Federal government. Provide plan information to eligible employees - As you put your 401(k) plan in place, you must notify employees who are eligible to participate in the plan about your plan’s benefits and requirements. A summary plan description or SPD is the primary vehicle to inform participants and beneficiaries about the plan and how it operates. The SPD typically is created with the plan document. You will need to send it to all plan participants. In addition you may want to provide your employees with information that discusses the advantages of joining your 401(k) plan. Employee perks – such as pre-tax contributions to a 401(k) plan (or tax-free distributions in the case of Roth 401(k)s), employer contributions (if you choose to make them), and compounded tax-deferred earnings – help highlight the advantages of participating in the plan. Operating A 401(k) Plan |
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Participation
Employees cannot be excluded from a plan merely because they are older workers. Contributions Traditional 401(k) Plan For example, you may decide to add a percentage – say 50 percent – to an employee’s contribution, which results in a 50-cent increase for every dollar the employee sets aside. Using a matching contribution formula will provide additional employer contributions only to employees who make deferrals to the 401(k) plan. If you choose to make nonelective contributions, the employer makes a contribution for each eligible participant, whether or not the participant decides to make a salary deferral to his or her 401(k) account. Under a traditional 401(k) plan, you may have the flexibility of changing the amount of nonelective contributions each year, according to business conditions. Safe Harbor 401(k) Plan SIMPLE 401(k) Plan
No other employer contributions can be made to a SIMPLE 401(k) plan, and employees cannot participate in any other retirement plan of the employer. The maximum amount that employees can contribute to their SIMPLE 401(k) accounts is $10,000 in 2005. For years after 2006, annual cost-of-living updates can be found at www.irs.gov/ep. An additional catch-up contribution is allowed for employees aged 50 and over. The additional contribution amount is $2,000 for 2005 and $2,500 for 2006. Contribution Limits
In addition, the amount employees can contribute (elective deferrals) before taxes under a traditional or safe harbor 401(k) plan is limited to $14,000 for 2005 and $15,000 for 2006. Traditional and safe harbor 401(k) plans can allow the following additional catch-up contributions for employees aged 50 and over:
Vesting In SIMPLE 401(k) plans and safe harbor 401(k) plans, all required employer contributions are always 100 percent vested. In traditional 401(k) plans, you can design your plan so that employer contributions become vested over time, according to a vesting schedule. Nondiscrimination Traditional 401(k) plans are subject to annual testing to assure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers. Safe harbor 401(k) plans and SIMPLE 401(k) plans are not subject to annual non-discrimination testing. Investing 401(k) Monies Fiduciary Responsibilities Some decisions with respect to a plan that are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and thus, in making decisions, are acting as fiduciaries. Basic Responsibilities
These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties. The responsibility to be prudent covers a wide range of functions needed to operate a plan. And, since all these functions must be carried out in the same manner as a prudent person would carry them out, it may be in your best interest to consult experts in the various fields, such as investments and accounting. In addition, for some functions, there are specific rules that help guide the fiduciary. For example, if your plan provides for salary reductions from employees’ paychecks for contribution to the plan, then these contributions must be timely deposited. The law states that this must be accomplished as soon as it is reasonably possible to do so, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter time frame, you need to make the deposits at that time. Limiting Liability The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the end results. For example, if you or someone you hire makes the investment decisions for the plan, an investment does not have to be a “winner” if it was part of a prudent overall diversified investment portfolio for the plan. Since a fiduciary needs to carry out activities through a prudent process, you should document the decision-making process to demonstrate the rationale behind the decision at the time it was made. In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to give participants control of the investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. If properly executed, this type of plan limits your liability for the investment decisions made by participants. You can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability. Hiring a Service Provider Some items to consider in selecting a plan service provider:
Once hired, these are additional actions to take when monitoring a service provider:
(For more information, see Understanding Retirement Plan Fees and Expenses and a sample fee disclosure form at www.dol.gov/ebsa. Click on "Publications," then "Compliance Assistance Pension Publications" to access 401(k) Plan Fees Disclosure Form. Prohibited Transactions and Exemptions For example, there is an exemption that permits you to offer loans to participants through your plan. If you do, the loan program must be carried out in such a way that the plan and all other participants are protected. Thus, the decision with respect to each loan request is treated as a plan investment and considered accordingly. Bonding Disclosing Plan Information to Participants The summary plan description (SPD) – the basic descriptive document - is a plain-language explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It also informs participants about the features and what to expect of the plan. Among other things, the SPD must include information about:
The SPD should include an explanation about the administrative expenses that will be paid by the plan. This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan. A summary of material modification (SMM) apprises participants of changes made to the plan or to the information required to be in the SPD. The SMM or an updated SPD must be automatically furnished to participants within a specified number of days after the change. An individual benefit statement (IBS) shows the total plan benefits earned by a participant and information on their vested benefits. The IBS must be provided when a participant submits a written request, but no more than once in a 12-month period, and automatically to certain participants who have terminated service with the employer. In addition, many plans choose to provide on a quarterly basis individual account statements that show the assets in a participant’s account, how it is invested, and any increases (or decreases) in investments during the period covered by the statement. A summary annual report (SAR) is a narrative of the plan’s annual return/report, the Form 5500, filed with the Federal government (see Reporting to Government Agencies for more information). It must be furnished annually to participants. A blackout period notice gives employees advance notice when a blackout period occurs, typically when plans change record keepers or investment options, or when plans add participants due to corporate mergers or acquisitions. During a blackout period, participants’ rights to direct investments, take loans, or obtain distributions are suspended. Reporting to Government Agencies Form 5500 series
For 401(k) plans, the Form 5500 is designed to disclose information about the plan and its operation to the IRS, the U.S. Department of Labor, plan participants, and the public. Most one-participant plans (sole proprietor and partnership plans) with total assets of $100,000 or less are exempt from the annual filing requirement. A final return/report must be filed when a plan is terminated regardless of the value of the plan’s assets. Form 1099-R Distributing Plan Benefits When participants are eligible to receive a distribution, they typically can elect to:
Terminating A 401(k) Plan Typically, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500. You must also notify your employees that the 401(k) plan will be discontinued. Check with your plan’s financial institution or a retirement plan professional to see what further action is necessary to terminate your 401(k). See Form 5310 and the Form 5310 Instructions for additional information. Compliance
For help in establishing and operating a 401(k) plan, you may want to talk to a retirement plan professional or a representative of a financial institution that offers retirement plans – and take advantage of the help available in the following Resources section. Resources The Web sites feature this publication as well as additional information on 401(k) plans and other retirement plans, as listed below. Publications can be ordered by calling the appropriate agency’s toll free number – for the IRS, 1.800.TAX-FORM (1.800.829.3676) or for DOL, 1.866.444.EBSA (3272). The following items, issued by both the IRS and DOL, are available on the Web and through the toll free numbers:
Related materials available from DOL:
In addition, DOL sponsors two interactive Web sites - the Small Business Advisor, available at the DOL Web address noted above, and, along with the U.S. Chamber of Commerce and the Small Business Administration, www.selectaretirementplan.org. For employees:
Related materials available from the IRS:
401(k) Plans for Small Businesses is a joint project of the U.S. Department of Labor's Employee Benefits Security Administration (EBSA) and the Internal Revenue Service. This publication and other EBSA materials are availabe by calling toll-free 1.866.444.EBSA (3272) or visit the agency's Web site at www.dol.gov/ebsa. 401(k) Plans for Small Businesses (IRS Publication 4222) is also available from the Internal Revenue Service at 1.800.TAX-FORM (1.800.829.3676). Please indicate publication number when ordering. This material is available to sensory impaired individuals upon request: Voice phone: 202.693.8644, TDD: 202.501.3911. |
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