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401(k) Challenges in Troubled Economic Times |
In these troubled economic times, it is vital that companies pay close attention to the proper operation of sponsored 401(k) plans.
The need for close attention to the plan is especially important now because troubled economic times and difficult investment markets are affecting almost all 401(k) plans. We have outlined seven important steps you can take to minimize the risk of costly financial consequences relating to your 401(k) plan’s investments, contributions, compliance testing and in-house operations.
1. Review your plan’s investment options from a fiduciary perspective.
- Make sure your plan has an Investment Policy Statement that lists your criteria for selecting and monitoring the menu of investment options offered to participants. This is a crucial part of protecting the employer and trustees from fiduciary liability for investment losses incurred by participants during this declining market.
- Manage the plan’s investments in a manner that provides maximum fiduciary protection for the employer and the trustees under ERISA Sec. 404(c).
2. Review the affordability of employer contributions under your plan.
- Look at your budget to see if you can afford the level of employer contributions(matching and/or profit sharing) that are either specified in your plan document or that your employees are expecting to receive.
- If your plan has a fixed contribution rate stated in the plan document, you must consider your company’s ability to fund the required cost. If you are uncertain about your ability to meet that obligation this year, discuss with your plan advisors what options you have to reduce, suspend, or eliminate the required contribution.
3. Consider the effect of contribution changes on your plan’s annual compliance tests.
- If you reduce or suspend the employer matching contribution, some employees may reduce or suspend their salary deferrals. Lower salary deferral participation by non-highly compensated employees (NHCEs) may make the plan fail the ADP and/or ACP tests that limit salary deferrals or matching contributions for highly compensated employees (HCEs).
- If you reduce or suspend a safe harbor matching contribution during the year, the plan will lose its safe harbor status for the entire year and must be subject to ADP and ACP testing that year.
- If your plan is a top-heavy plan (a plan in which 60% of more of the benefits belong to owners or certain officers of the business), any salary deferral contributions made by owners or officers of the company during the year could trigger a mandatory top-heavy minimum employer contribution for that year.
4. Maintain timely deposits of employee salary deferrals.
- Do not be tempted to delay the deposit of your employees’ salary deferrals (and/or loan payments) when cash flow is tight. U.S. Department of Labor regulations require these amounts be deposited into the plan as soon as administratively possible after the date they are withheld from payroll.
- Late deposits of employees’ deferrals and/or loan payments must be reported to the Department of Labor on the annual Form 5500 and will subject your company to penalties as well as the cost of restoring lost earnings to affected participants’ accounts.
5. Expect more frequent requests for plan loans and/or hardship withdrawals.
- Due to the severe effect of the economy on many individuals and their families, more participants than usual may be requesting loans or hardship withdrawals from your plan.
- Some employees may stop making their loan repayments to the plan and default on the remaining loan balance. These loan defaults must be reported to the IRS as a deemed taxable distribution from the plan to the employee. You must notify your plan service providers whenever a loan default occurs, so they can prepare the necessary Form 1099-R that year.
6. Watch out for special vesting rules that can be triggered by layoffs.
- If your company lays off a significant portion of the employees eligible to participate in the 401(k) plan, the plan would be treated as having had a “partial termination”, which would result in the laid-off employees becoming 100% vested under the plan. Generally, a layoff of at least 20% of eligible plan participants during one year would be treated as a partial termination.
7. Establish a policy for interim valuations of any pooled investment accounts.
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If your 401(k) plan has any pooled accounts that are not valued on a daily basis at the participant level, consider establishing a policy to determine the circumstances the plan would automatically require an interim valuation of the pooled account before paying out benefits to terminated participants.
Source: RSM McGladrey
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