Employer Retirement Plans

ERISA stands for the Employee Retirement Income Security Act of 1974, which protects the retirement assets of American workers by governing how employers provide benefit plans to employees. ERISA established rules and duties that qualified plans and plan fiduciaries must follow to ensure decisions are made in the best interest of plan participants and that plan assets are not misused. ERISA is enforced by the Employee Benefits Security Administration (EBSA), which is an agency of the U.S. Department of Labor (DOL).

There are two overarching categories of employer retirement plans: qualified plans and nonqualified plans. In simple terms, a qualified plan is one that meets ERISA guidelines and standards concerning plan eligibility, discrimination, participation, vesting, benefit accrual, funding, information and communication. Meanwhile, a nonqualified plan is not subject to these same guidelines.

There are numerous types of employer retirement plans within these two categories. Common types of qualified plans include:

• Employer 401(k) plans
• 403(b) plans
• Simplified Employee Pension (SEP) Plans
• Stock bonus plans
• Employee stock ownership plans

Meanwhile, nonqualified plans are most likely to be offered to select groups of employees, such as key executives, whose needs are not met by qualified plans due to contribution limits. Types of nonqualified retirement plans include:

• Salary reduction plans
• Bonus deferral plans
• Supplemental executive retirement plans
• Excess benefit plans

The difference between defined benefit plans and defined contribution plans lies in what is promised to plan participants. Defined benefit plans offer a specific payment upon retirement. This defined payment may be a fixed dollar amount, or it may depend on a formula that considers factors such as salary and tenure. An example of a defined benefit plan is a pension plan.

Conversely, in a defined contribution plan, the participant and/or the employer contribute to the participant’s individual retirement account (IRA) under the plan, and the participant receives the balance of their account upon retirement. In this case, there is no specific payment promised—rather, the benefit received depends upon the contributions, plus or minus any investment gains or losses. One of the most common forms of defined contribution plans is the employer 401(k) plan.

An employer 401(k) plan is a form of employer-sponsored retirement savings plan that allows a participating employee to have a percentage of each paycheck contributed directly to a tax-advantaged investment account. Often, the employer will “match” part or all of the employee’s contribution, meaning they will contribute to the account as well. The employee typically chooses from a range of investment options, often including mutual funds, which are selected by the plan sponsor (usually the employer).

There are two main types of 401(k) plans, and each has unique tax benefits:

• In a traditional 401(k), contributions are taken from the employee’s paycheck before tax, so taxes are deferred on the contributions. This means taxes are only assessed upon withdrawal, which is usually in retirement. These tax-deferred contributions lower the employee’s taxable income in the year of the contribution. Additionally, investment returns, such as dividends and interest, are reinvested in the traditional 401(k) plan account, and thus not taxed.
• In a Roth 401(k), contributions are taken from the employee’s after-tax income. This means there is no tax deduction in the year of the contribution; however, no additional taxes are owed on the contribution or the investment earnings when the money is withdrawn in retirement (given the employee is at least 59½ years old and has had the Roth 401(k) for a minimum of five years).

The benefits of an employer 401(k) plan are significant for both employees and employers alike.

For employers, a 401(k) plan is an important measure for recruiting and retaining top talent. Retirement benefits are highly valued by job seekers, and may be a key factor in an employee’s decision of whether to accept or stay in a position. Additionally, the Internal Revenue Service (IRS) incentivizes employer contribution matching by allowing employers to deduct 401(k) contributions from their federal income taxes, given the employer’s contributions do not exceed certain limitations.

For employees, an employer 401(k) plan offers easy access to a tax-advantaged retirement savings vehicle. Saving for retirement is often a large factor of employee financial stress. A 401(k) plan is a hassle-free way for employees to save and reduce this financial stress, as contributions are typically automatically deducted from their paycheck. Additionally, if their employers offer contribution matching, employees receive a free (and over the long run, significant) boost to their retirement saving efforts.

It is ultimately up to the plan sponsor to determine eligibility for their 401(k) plan, though they must comply by the minimum requirements set by ERISA and the Internal Revenue Code. Under the maximum exclusions, an employer 401(k) plan may exclude employees who are under age 21 and/or who have not yet completed a year of service with the company (1,000 or more hours worked in a 12-month period).

However, many employers find that more generous eligibility is advantageous for recruiting and retention purposes—for example, allowing employees to enroll immediately in the plan, rather than waiting one year, may make for a more competitive retirement benefit.

Once you determine the eligibility requirements for your plan, it must be documented in the detailed plan document, as well as the Summary Plan Description (SPD), which explains key rules of the plan for employee reference.

Employers have the option to match a certain amount of their employees’ contributions to the 401(k) plan account. Contribution matching is not required within a 401(k) plan, but it is often used by employers as an added benefit in the employee benefits package, and to encourage employees to save more for retirement.

• Partial matching: The employer matches part of the money an employee contributes, up to a certain amount. For example, an employer may match 50% of what an employee contributes, up to 6% of their salary. In this case, the employer matches half of an employee’s contribution, but contributes no more than 3% of the employee’s salary in total. The employee may contribute more than 6% of their salary, but the employer’s contribution will still not exceed 3%.
• Dollar-for-dollar matching: The employer matches the amount of money an employee contributes, up to a certain amount. For example, an employer may match 100% of an employee’s contributions, up to 3% of the employee’s salary. In this case, if the employee contributes less than 3%, so will the employer; if an employee contributes more than 3%, the employer’s match will still not exceed 3%.

The IRS determines limits for how much employees and employers can contribute to a 401(k) on an annual basis, based on inflation and cost of living. The 2022 contribution limits for employer 401(k) plans are as follows:

• Employee contributions: Individuals may contribute up to $20,500 to their 401(k). If the participant is over 50 years old, they can contribute an additional $6,500 (known as the catch-up contribution)
• Total employee and employer contributions: Total contributions to an employer 401(k) plan account cannot exceed the lesser of $61,000 or 100% of the employee’s salary (or, with the catch-up contribution, $67,500)

• Immediate vesting: An employee owns 100% of their employer’s contributions, immediately.
• Graded vesting: An employee owns a growing percentage of their employer’s contributions over time. Employers who use a graded vesting schedule must ensure employees own 20% of the contributions by the end of their second year of employment, and 100% by the end of six years.
• Cliff vesting: An employee does not own any of their employer contributions until they reach a certain tenure, when they are then fully vested. Employers on a cliff vesting schedule must ensure their employees own 100% of the contributions by the end of their third year with the company.

Yes, employer 401(k) plans are permitted (but not required) to offer loans to participants. Loan amounts are limited to the lesser of $50,000 or 50 percent of the employee’s vested account balance. The borrowing employee must pay interest on the loan; however, the interest is paid to their 401(k) plan account, not to a bank or lender.

The rules for borrowing must be established by the employer 401(k) plan, and thus are different for every plan. For example, some plans only allow employees to take out loans for specific reasons or under specific conditions. The plan administrator is also responsible for determining the loan interest rate, which is usually based on the prime rate of interest.

When determining whether to offer loans, employers should consider both the advantages and downsides. For example, a 401(k) loan could be a lifeline for an employee during a hard time, but it is also possible the borrowing employee will be unable to pay the loan back. Additionally, borrowing is likely to slow the growth of the employee’s 401(k) account, as the money borrowed is no longer earning investment returns.

• Plan Sponsor: The entity that establishes the 401(k) plan for the company and its employees—typically the employer itself.
• Plan Administrator: The entity, selected by the plan sponsor, that oversees operation and day-to-day administration of the 401(k) plan.
• Named Fiduciary: The person or entity that has ultimate authority over fiduciary decisions for the plan. By law, the Named Fiduciary must act solely in the interest of plan participants and beneficiaries. The fiduciary is legally responsible for selecting the plan’s investment options and monitoring their suitability, though some of these responsibilities can be delegated to the Trustee or an investment manager.
• Trustee: An individual employee of the plan sponsor, or an outside corporate trustee, who has the fiduciary responsibility of ensuring plan assets are being managed in the best interest of plan participants and in accordance with the plan document. ERISA requires that a qualified 401(k) plan’s assets be held in a trust by one or more trustees.

Boulay Financial Advisors, LLC designs, implements, administers, and advises on employer 401(k) plans and other types of employer retirement plans. Our fiduciary advice and services help our clients make the right decisions to ensure their plan is best suited for their organization, while meeting the needs of their employees. Our employer retirement plan services are divided into four categories:

• Fiduciary Support: We work closely with our plan sponsor clients as a co-fiduciary to help them understand their responsibilities and obligations, provide ongoing governance and support for the committee, and remain compliant within the ever-evolving ERISA landscape. 
• Plan Design: Leaning on our expertise, we provide strategic employer 401(k) plan design services to create a plan that aligns with your organizational goals and maximizes the value for all parties.
• Participant Education: To ensure your employees can fully enjoy the benefits of your plan, they need to be equipped with the necessary knowledge and tools to make the right investment decisions and work toward retirement readiness. We help you engage your participants through ongoing education and advice that is clear, direct, and understandable. Our team of educators communicate effectively to a broad audience on a wide variety of financial topics.
• Investment Advisory: We work closely with you and your investment committee to tailor a disciplined and flexible investment process. We provide our plan sponsor clients with timely feedback and help them make critical decisions to provide plan participants with competitive investments, keeping their long-term financial success in mind.

To get answers to any questions that are not on this list, or to schedule a meeting with a member of Boulay’s Retirement Plan Advisory team, connect with us today.