What's In a Name?

What’s the most used and least understood/appreciated acronym in the retirement plan industry?

Well, for my money, it’s “TPA”—short for “third-party administrator.” It’s a term that is widely bandied about, but I think misunderstood by many.

The origins are plain enough—“administrator” in the sense that a TPA deals with plan administration process and issues. The issues and process, it bears noting, that ERISA (not to mention the IRS and DOL) presumes are the responsibility of the plan fiduciary. We’re talking about things like ensuring that the terms of the plan document are adhered to, that non-discrimination tests are properly applied, and that contributions are timely deposited. 

Where things seem to get confused is the “third party” reference. At its simplest, it’s merely an acknowledgement that the entity performing those vital plan administration functions is someone other than the entity responsible under the law. They are, quite simply, a party external to that legal circle. They are legally an extension of the plan sponsor/administrator, and though it’s hard to imagine it these days, it harkens back to a time when the plan sponsor/employer actually did all that work in-house, often on 12-column pads and calculators. 

Over time the role of TPA has been diminished in the eyes of many. Sure, they deal with a lot of technical “minutiae”—we’re talking deep in the “weeds” here. The classic reference is you ask what time it is, and they (some, anyway) first want to explain to you how a watch is made. That said, the role of plan administrator—perhaps a better label would be compliance administrator—is essential—critical—to the smooth, effective and efficient running of a plan—and on aspects that, odds are, your recordkeeper (another critical role, but one often focused on other things) isn’t always.

Here’s a partial list—bearing in mind that every plan has to do these things, ask yourself—and your plan sponsor clients—who is making sure that:

1. All eligible workers are included in the plan—as required by law—and ineligible workers are not unduly credited with benefits?
2. 
   Compensation used as the basis for contributions and/or eligibility is accurate, in accordance with ERISA and IRS limits, both with regard to amount (how much) and individuals (who)?
3. The plan’s allocation of benefits meets legal requirements and the correct individuals receive the correct amount(s), thus preventing the need for corrective measures and penalties? 
4. The amount(s) allocated to individual participant accounts match the actual dollars deposited into the plan/trust. Additionally, to ensure that contribution deposits are made to the plan/trust in accordance with legal requirements, forestalling legal fines and penalties?
5. The appropriate plan notices are timely delivered to the applicable individuals in accordance with legal requirements, providing them with important plan information and instructions (and preventing the application of penalties for failing to do so)?
6. Employees are properly categorized as to their status as highly compensated employees (HCEs), key employees (for top-heavy testing) and spousal/familial relationships so that the allocation of benefits and eligibility is appropriate and consistent with legal requirements?
7. The tax filings related to the plan (Form 5500, 8955, 5330, etc.) are filed accurately and on time in order to comply with the legal requirements regarding the plan, and thus avoid fines and penalties?
8. The amounts distributed as loans or distributions are consistent with the vesting schedule of the plan, in accordance with plan parameters and legal limits—and that the needed authorizations are obtained?

And perhaps most critically, who is there to help ensure that problems with regard to plan operation—perhaps relating to any/all of the items above—are promptly and accurately corrected in accordance with government platforms and processes to minimize the pain, time—and financial penalties—involved?

These are questions to which prudent fiduciaries—and those who support them—should know the answer(s).

Trust me—the IRS and DOL expect that you do—and ERISA expects nothing less.

- Nevin E. Adams, JD

(A Little More) Room to Grow

 Several years ago, we had in mind that it would be fun to get an aquarium for our home, and (even) I got excited at the prospects of filling it with a variety of all kinds and sizes of exotic fish. 

Sadly, those hopes were dashed when I discovered that , despite the massive displays of what appeared to be whole schools of fish in similarly sized tanks at the pet store, our specific-sized tank would only support a handful of the fish I had hoped to display. Apparently, the more fish you want to have (that live), the bigger the tank you need. The reason: they need room to thrive and grow.

At long last the IRS last week announced the new contribution and benefit limits for 2022. Considering the run-up in inflation this year, expectations were similarly high for increases in those limits. And sure enough, among other things, the 401(k) limit was bumped $1,000 (to $20,500) and the defined benefit plan limit rose from $230,000 to $245,000, though the limit for catch-up contribution held level at $6,500. 

At the outset, it’s worth remembering that these adjustments only reflect increases in the cost of living—basically an acknowledgement that the costs of living in retirement change over time, that they increase due to inflation—and that they are timed in such a way that those increases must accumulate to a certain level before that acknowledgement in the form of increased levels kicks in.

But since industry surveys[i] suggest that “only” about 9%-12% currently contribute to those levels, does it matter? And why don’t more people max out on those contributions? Well, cynics might say it’s because only the wealthy can afford to set aside that much.[ii] But Vanguard’s data suggests that only about half (56%) of even those workers making more than $150,000 a year maxed out their contributions. If these limits and incentives work only to the advantage of the well-off, why aren’t more maxing out?

Limit ‘Ed’

Those who look only at the outside of the current tax incentives generally gloss over the reality that there are a whole series of benefit/contribution limits and nondiscrimination test requirements. These rules are, by their very design, intended to maintain a balance between the benefits that these programs provide between more highly compensated individuals and the rest of the plan participants (those rules also help to ensure a broad-based eligibility for these programs). Almost assuredly those limits are working to cap the contributions of individuals who would certainly like to put more aside, if the combination of laws and limits allowed.[iii]

But let’s think for a minute about a group that doesn’t get nearly enough attention: the group— millions of working Americans, in fact—who are not wealthy by any objective measure, but earn enough that Social Security won’t come close to replicating their pre-retirement income. These middle and upper-middle income individuals apparently aren’t the concern of those who want to do away with the 401(k)—but these are the individuals who in many, if not most, situations, not only make the decision to sponsor these plans in the first place—they make the ongoing financial commit to make an employer match.

If nothing else, allowing those contribution limits to keep pace with inflation—like the right-sized aquarium—provides us all not only with a little more room to grow our retirement savings—but reminds us (all) of the opportunity to do so.

- Nevin E. Adams, JD

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[i] According to Vanguard, during 2020, 12% of participants saved the statutory maximum dollar amount of $19,500 ($26,000 for participants age 50 or older). Fifty-six percent of participants with an income of more than $150,000 contributed the maximum allowed. 

[ii] Setting aside for a minute that $20,000/year likely won’t make much of a dent in the replacement rate for a wealthy individual.

[iii] For some additional validation of the impact of these limits, see “Upside” Potential.

The ‘Free’ Retirement Money Many Overlook

People often talk about the significance of the “free” money associated with the company match in retirement savings – but there’s another source of “free” money that is often overlooked.

I’m talking about the so-called Saver’s Credit, more precisely the Retirement Savings Contributions Credit. It’s a credit, not a deduction – a dollar-for-dollar reduction of tax liability.

Income Limits

For those who qualify, in addition to the customary benefits of workplace retirement savings, it could mean a $1,000 break on their taxes — twice that if married and file a joint return. In fact, for a moderate income saver, it can offset 50%, 20% or 10% of retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on adjusted gross income.

Speaking of which, the Saver’s Credit can be claimed by:

• married couples filing jointly with incomes up to $61,500 in 2016;
• heads of households with incomes up to $46,125 in 2016;
• married individuals filing separately; and
• singles with incomes up to $30,750 in 2016.

Additionally, in order to claim the credit, individuals must be 18 years or older, must not be a full-time student, and cannot be claimed as a dependent on another person’s return.

5 Things You May Not Know

Here are five things you may not know about the Saver’s Credit:

• It applies to a variety of retirement savings. The Saver’s Credit can be taken for contributions to a traditional or Roth IRA (including myRA), a 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan, as well as voluntary after-tax employee contributions to qualified retirement and 403(b) plans.
• There are two deadlines for contributions. To qualify for the Saver’s Credit, contributions must be made to 401(k)s, 403(b)s, 457s or the federal government’s Thrift Savings Plan by the end of the calendar year. However, taxpayers have until April 18, the due date for filing a 2016 tax return, to set up a new individual retirement arrangement or add money to an existing plan for 2016.
• Rollover contributions aren’t eligible for the Saver’s Credit. Eligible contributions may be reduced by any recent distributions (for 2015, distributions received after 2012, and before the due date of the 2015 return, including extensions) from a retirement plan or IRA (a list of these distributions is available here.)
• You have to file Form 1040, Form 1040A, or Form 1040NR to claim the credit. The Saver’s Credit is (still) not available via the 1040-EZ form (though there have been legislative attempts to remedy that situation). However, if you use tax software, such as TaxAct or TurboTax, it should calculate the credit for you if you report your retirement contributions. Look for a completed Form 8880 in the attachments that your tax software provides.
• You only get the credit if you file for it. Just 24% of American workers with annual household incomes of less than $50,000 are aware of the credit, according to the 15th Annual Transamerica Retirement Survey.

However, it’s not too late to save and get “credit” for doing so – make sure the participants you work with, and plan sponsors you work for – are aware.

- Nevin E. Adams, JD

See also:

• What’s Wrong With the Saver’s Credit?
• 7 Things You May Not Know About the Saver’s Credit (and 4 You Should)
• Save Twice with the Saver’s Credit

 

7 Common Retirement Plan Mistakes

The headlines are all about revenue-sharing, conflicts of interest and statutes of limitation — but the things that are likely to get plans and plan sponsors in trouble are a lot more mundane.

Here are seven that are more likely to gum up the works for your average plan sponsor.

1. Not following the terms of the plan document regarding the administration of loan provisions (maximum amounts, repayment schedules, etc.) or hardship withdrawals.

Plan documents routinely provide that hardship distributions can only be obtained for certain very specific reasons, and that participants first avail themselves of all other sources of financing before applying for hardship distributions. (These conditions often are incorporated directly from the requirements of the law.) Similarly, loans are permissible from these programs only when they comply with certain standards regarding the amount, purpose and repayment terms.

Failure to ensure that these legal requirements are met can, of course, result in a distribution that is not authorized under the terms of the plan document. And since these types of distributions are often spent quickly by participants, and thus are not readily recoverable, it can be complicated and time-consuming to set the situation right.

Oh, and don’t forget that administrative procedures for dealing with such things have been known to be, or become, inconsistent with plan documents over time.

2. Failure to follow plan document eligibility and vesting provisions.

The plan document also spells out employees’ rights to retirement benefits and the formulas for determining them based on the correct application of service and/or age requirements of the plan regarding eligibility for participation, as well as the proper application of the plan’s vesting schedule.

To comply with those requirements, you need to maintain accurate service records for all employees. If these records are incorrect, the benefits provided may be incorrect — either in excess of what is permissible or less than what was due to the participant. Note that the failure to properly follow the plan’s provisions can cause the plan to lose its qualified status.

The plan document serves as the foundation for plan operations; simply put, it is the operating manual for the plan. Sometimes, particularly if you are relying on a document that has been prepared by a third-party service provider, certain “gaps” can emerge between what the document allows and how the plan is actually administered. As a result, it is a good idea to conduct a document/process “audit” every couple of years. Don’t assume that “the way we’ve always done things” is supported by the legal document governing your plan.

3. Not keeping your plan document up to date.

As central to the plan’s operation as the plan document should be, it needs to be updated when the tax laws affecting 401(k) plans change. The IRS generally establishes a firm deadline by which plan amendments reflecting tax law changes must be adopted. If you don’t remember the last time you updated your plan, you’re probably overdue.

4. Not starting required minimum distributions (RMDs) on time.

A minimum payment must be made to the participant by the required beginning date (RBD) and for each following year. Normally, the RBD for a participant who is not a 5% owner is April 1 following the end of the calendar year in which the latter of two events occurs: either the participant reaches age 70½ or the participant retires. For 5% owners, the RBD is April 1 following the end of the calendar year in which they attain age 70½ regardless of their retirement date.

Plan sponsors often discover that required minimum payments either have not been paid on a timely basis or have not been paid at all, especially when a non-5% owner continues working after reaching age 70½. Failure to follow the minimum payment rules as written in the plan document can lead to the loss of the plan’s tax-qualified status. If participants or beneficiaries do not receive their minimum distribution on time, they — not the plan — are subject to a 50% additional tax on the underpayment.

5. Not depositing participant contributions on a timely basis.

The legal requirements for depositing contributions to the plan are perhaps the most widely misunderstood elements of plan administration. A delay in contribution deposits is also one of the most common flags that an employer is in financial trouble — and that the Labor Department is likely to investigate.

Note that the law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. If employers can reasonably make the deposits sooner, they need to do so. Many have read the worst-case situation (the 15th business day of the month following) to be the legal requirement. It is not.

Note also that the rules about the timing of matching contributions or other employer contributions are different than those for elective deferrals.

6. Failing to obtain spousal consent.

A common plan mistake submitted for correction under the Voluntary Correction Program (VCP) is the distribution to a participant of a benefit in a form other than the required QJSA (e.g., a single lump sum) without securing proper consent from the spouse. This often happens when the sponsor’s HR accounting system incorrectly classifies a participant as not married (or when the participant was not married at one point and subsequently married or remarried).

The failure to provide proper spousal consent is an operational qualification mistake that would cause the plan to lose its tax-qualified status.

7. Paying expenses from the plan that are not eligible to be paid from plan assets.

Assuming that the plan allows it (another plan document check), the Department of Labor has divided plan expenses into two types: so-called “settlor expenses,” which must be borne by the employer; and administrative expenses, which — if they are reasonable — may be paid from plan assets. In general, settlor expenses include the cost of any services provided to establish, terminate or design the plan. These are the types of services that generally are seen as benefiting the employer, rather than the plan beneficiaries.

Administrative expenses include fees and costs associated with things like amending the plan to keep it in compliance with tax laws, conducting nondiscrimination testing, performing participant recordkeeping services or providing plan information to participants.

- Nevin E. Adams, JD

IRS Guidance Available
 
As for plans that fall short of any of the above, the IRS has resources available to help you identify these problems before they occur — and an outline of how to go about fixing them if they do occur. And should you find a plan in one of the foregoing predicaments, you might want to check out these resources from the IRS:

• If you haven’t updated your plan document.

• If you have issues with required minimum distributions.

• If you haven’t made contributions on a timely basis.

• If you didn’t get spousal consent.

Room to Grow

Several months back we acquired an aquarium, and I looked forward to filling it up with all kinds and sizes of exotic fish – only to be disappointed to find out that, despite the massive displays of what appeared to be whole schools of fish in similar sized tanks at the pet store, our tank would only support a handful of the fish I had hoped to display. The reason; they need room to thrive and grow. The more fish you want to have (and live), the bigger the tank.

The IRS has now announced the new contribution and benefit limits for 2015. Most were increased, notably the annual contribution limits for 401(k), 403(b), and 457 plans (from $17,500, where it has been for the past two years, to $18,000) and the catch-up contributions for those over age 50 (from $5,500, where it has remained since 2009, to $6,000).

But since industry surveys suggest that “only” about 9%-12% currently contribute to those levels, does it matter?

It’s worth remembering, of course, that these adjustments only reflect increases in the cost of living; you’d need more than $6,000 to buy what that $5,500 catch-up contribution would have gotten you in 2009. Moreover, they are timed in such a way that those increases must accumulate to a certain level before the adjustment kicks in.

But why don’t more people max out on those contributions? Well, cynics might say it’s because only the wealthy can afford to set aside that much. But at Vanguard only 36% of workers making more than $100,000 a year maxed out their contributions. If these limits and incentives work only to the advantage of the rich, why aren’t more maxing out?

Limit 'Ed'

Those who look only at the outside of the current tax incentives generally gloss over the reality that there are a whole series of benefit/contribution limits and nondiscrimination test requirements. These rules are, by their very design, intended to maintain a balance between the benefits that these programs provide between more highly compensated individuals and the rest of the plan participants (those rules also help to ensure a broad-based eligibility for these programs). Surely those limits are working to cap the contributions of individuals who would surely like to put more aside, if the combination of laws and limits allowed.

In that vein, one of the comments you hear frequently from those who want to do away with the current retirement system is that the tax incentives for 401(k)s are “upside down,” that they go primarily to those at higher income levels, those who perhaps don’t need the encouragement to save. And from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes. Indeed, if those “upside-down incentives” were the only forces at work, one might reasonably expect to find that the higher the individual’s salary, the higher the overall account balance would be, as a multiple of salary.

However, drawing on the actual administrative data from the EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), the nonpartisan Employee Benefit Research Institute found that those ratios were relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000. In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes — and not “upside down.”

Again, what keeps these potential disparities in check is the series of limits and nondiscrimination test requirements: the boundaries established by Internal Revenue Code Sections 402(g) and 415(c), combined with ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to do just that — to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

But let’s think for a minute about a group that doesn’t get nearly enough attention. It’s the group — millions of working Americans, in fact — who are not wealthy, but they earn enough that Social Security won’t come close to replicating their pre-retirement income.

These middle, and upper-middle income individuals apparently aren’t the concern of those who want to do away with the 401(k) — but, their personal retirement needs notwithstanding, these are the individuals who in many, if not most, situations, not only make the decision to sponsor these plans in the first place — they make the ongoing financial commit to make an employer match.

Allowing those contribution limits to keep pace with inflation not only helps remind us all of the importance of saving more — like the right-sized aquarium, it also helps provide us all with a little more room to grow our retirement savings.

- Nevin E. Adams, JD

Compliance “Deportment”

Recently, the Internal Revenue Service (IRS) announced that it was sending a questionnaire out to about a thousand 401(k) plan sponsors. The IRS said it developed the questionnaire because of the “critical role 401(k) plans play in our private retirement system” (see “IRS Provides 401(k) Questionnaire Details”).

Make no mistake: It’s going to take some effort to respond to the questionnaire—and respond you must. Described as a “compliance check,” the IRS notes that “failure to complete the Questionnaire will result in further enforcement action.” So, what does the IRS want to know?

Well, there’s a lot of information to be gathered about the plan from plan years going back to 2006: the number of employees, participants, their deferral levels, eligibility standards, service and age requirements, the existence and administration of loans and hardship withdrawals, the results of nondiscrimination tests, the determination of top-heavy status, the level(s) of match, and any changes to those levels.

The more interesting part of the questionnaire, IMHO, is the other questions the IRS asks; things like, Have recent financial conditions led to an uptick in hardships and loans? Does the plan allow for Roth contributions (and how many participants have opted for that feature)? Can participants use a debit card to take a loan? And, for plans that embraced automatic enrollment, did they do so retroactively or prospectively? And I’m curious not only about what plan sponsors have to say about the impact of factors like age, compensation, matching levels, and plan communications on participation levels—but what the IRS might do with that information.

There are, however, some areas that seem a bit like a baited trap: questions about if notices are provided timely, if excess deferral contributions were returned within the legal timeframes, even if the respondent as a SIMPLE plan exceeded the contribution limits.

And, make no mistake, this is a prelude to something deeper. In unveiling the project, the IRS noted that its Employee Plans Examinations previously conducted a baseline study of 79 market segments, and “the findings indicated that 401(k) plans are by far the most non-compliant plan type in the retirement plan universe,” going on to note that “since these plans make up over 60% of the retirement plan universe, it is important to the future of the private retirement system that these plans maintain the highest level of compliance possible.”

What will the IRS do with the information? It says that it will “ultimately result in a report published by the IRS describing the responses and identifying those areas where additional education, guidance, and outreach is needed”—and, perhaps somewhat more ominously, help the IRS focus its enforcement efforts “to address and/or avoid non-compliance related to these plans.”

All in all, I wish the IRS questionnaire wasn’t quite so long, complicated, and—for lack of a better word—intimidating. For plan sponsors, I’m sure it’s going to wind up being one more thing that has to be done when they already don’t have enough hours in the day—and one that could serve to plant a big red flag on their plan, to boot.

Here’s hoping that some good comes out of it—that the IRS does indeed discover some areas in which they can help plan sponsors do a better job of keeping these important programs in compliance—and that, perhaps, it will find that the programs are in better shape than they seem to think they are.

—Nevin E. Adams, JD

More information is at http://www.irs.gov/retirement/article/0,,id=223440,00.html

A version of the online questionnaire is online HERE