401k Provisions Explained

Important

It is vitally important to ensure all policies and procedures in the Plan Documents are followed. There are no exceptions to provisions. Also, any changes to provisions must be first made at the Plan Document level, then provided to the Recordkeeper before they can be implemented. If you have any questions, please contact us first for proper guidance and assistance with managing the Plan.

Safe Harbor Election – General Information:

A company should consider electing a safe harbor designation if the owners or other Highly Compensated Employees (HCE) plan on deferring their wages in any meaningful way (i.e. more than $6k a year).  

• Pro 
  • Allows the owners and any other HCE to fully contribute to the 401k Plan without risk of corrective distributions. A corrective distribution is (money being returned based on average deferrals of non-highly compensated employees).
• Cons 
  • Employees are 100% vested in any Safe Harbor funds and no vesting schedule can be placed on this source of funds.  
  • Required annually, but can be changed if notice is given more than 90 days ahead of the start of the next Plan year.  
• There are two main Safe Harbor Formulas to choose from
  • SH Match – The company matches 100% of the first 3% of contributions and then 50% on the next 2% of compensation deferred. This is the more common of the formulas used if the company wishes to encourage employees to contribute in order to receive some portion from the company. Also, typically requires less out of pocket for the employer as typically not all employees will contribute to the 401k Plan.
    • Example: Employee A contributes 5% of his compensation, so he is matched the first 3% dollar for dollar and then 50% on the next 2% acquiring the full match available. If the employee only defers 2%, then he/she would only receive 2% match. If employee defers 10%, then they only receive a total of 4%, 100% on the first 3% and 50% of the next 2%
  • SH Non-Elective – The company automatically puts in 3% of every employee wages at the end of the year regardless of employee personal deferrals. This is typically more common if Profit Sharing is expected. This also typically includes wages for the full year regardless of when the employee enters the Plan.

Eligibility Requirements – General Information:

This determines when an employee is eligible for the Plan’s benefits. Typically, there is an age requirement of 21. The rest is very optional, but the most restrictive is a 1 year waiting period in which an employee must work 1000 hours to be eligible. Many other options are available and start up Plans can also include a waiver to make all current employees eligible regardless of hire date if desired.  

Entry Date Frequency – General Information:

After meeting eligibility criteria above, this is when an employee actual enters the plan and is eligible to start deferring and receiving employer contribution benefits. There are multiple options for entry with the most common being Semi-Annual, Monthly, Quarterly or Immediate. This decision should be made also based on company administration procedures. The more frequent the entry the more administrative burden is placed upon the employer to ensure materials are provided timely. The most restrictive is the Semi-Annual entry.

• Examples – Remember this is a two part process; Eligibility, then Entry
• An employee is hired on 2/6/2024 and satisfies eligibility on 2/5/2025 (assuming working 1000 hours). They will now Enter the Plan on the next approaching Semi-Annual entry date of 7/1/25.
• An employee is hired on 8/2/2024 and satisfies eligibility requirements by 8/1/2025. They will now Enter the Plan on the next available Semi-Annual entry date of 1/1/2026.

Automatic Enrollment – General Information:

With Secure Act 2.0, all new 401k plans will be required to have this feature available so incorporating now is typical. Automatic enrollment means once an employee becomes eligible, unless they opt out, they will automatically be enrolled at a specific rate which will then automatically increase annually until they opt out. They can always opt out by logging into their account and making an affirmative election regarding their contributions including if they want automatic 

An employer can choose any amount between 3-10% for automatic enrollment and up to 15% for auto-escalation. We typically recommend starting at around 6% with a max increase of 15%.  

Elective Deferral Changes – General Information:

An Employer can elect to restrict how often an employee can change their employee deferral percentages with options including anytime, monthly, quarterly, semi-annual, annually. Most employers select to modify elective deferrals each pay period, but this also can create some additional administrative work on behalf of the employer to keep up with any changes employees make. In a true integrated payroll/recordkeeper, this is less of an issue as it should occur automatically. We typically recommend per pay, but if some other frequency besides each pay is desired, we would recommend quarterly as creating too much of a restriction to contribute may deter employees from deferring. Keep in mind an employee can always move their contributions to 0% at anytime, but then would not be allowed to start contributions again until the next frequency period.  

Employer Contributions – General Information:

These funds include any Discretionary Matching, Profit Sharing or other non safe harbor non-elective contributions.  

• Discretionary matching can be done and almost any formula for a match can be created for an Employer match and can be changed annually.
• Profit Sharing can be done annually and changed annually on a Discretionary basis.
• Typically has a 2/6 Graded Vesting Schedule on these funds (0%, 20%, 40%, 60%, 80%, 100% vesting based on 1000 hours of service per year)

Other – General Information:

There are other provisions available in the Plan which we can discuss in more detail, but these are a few of the other key elements and our recommendations.  In general, all Plan Provisions are eligible for change with an Amendment, but sometimes there are notices required before changes become effective.  

• Loans – We do not recommend making loans available in the Plan participants.
• Hardship Distributions – We do not recommend making hardship distributions available to the Plan participants.
• Retirement Distributions – Employees are eligible to start distributions at age 59 ½ while actively employed.  
• Force out – Employees separated from service can be forced out of the Plan with balances under $7,000.