Being the bearer of bad news isn’t fun.
When the third-party administration firm relays that aspects of the annual compliance testing have failed causing many of the company’s executives to receive taxable distributions from the plan, it isn’t a great day for the HR manager. The administrator explains that the regulations require testing to prevent highly paid employees from receiving disproportionately greater benefits than other employees. At a much-needed lunch that day, the HR manager learns from a colleague that they once had the same issue but adopted a “safe harbor” design to solve the problem.
In their 61st Annual Survey of Profit Sharing and 401(k) Plans, the Plan Sponsor Council of America reports that, of the 605 plan sponsor respondents to the survey, 42% reported using a safe harbor design. Since December 1st, 2019 marks the last day to make a safe harbor election for 2020 calendar year plans, understanding the pros and cons of these elections will help you decide if a safe harbor design is the right choice for your plan.
Each year in a non-safe harbor plan, a series of nondiscrimination tests are performed to demonstrate that the contribution rates for highly compensated employees (HCEs) are not disproportionately larger than those for non-HCEs (NHCEs). HCEs are generally owners of more than 5% of the company and any employee with compensation in the prior plan year over a specified level ($125,000 for 2019). If a plan elects to be “safe harbor” for any given year, the compliance testing can be avoided by meeting the safe harbor standards. One of the main reasons for adopting a safe harbor design is to allow HCEs to defer up to the maximum dollar limit ($19,000 for 2019) without the potential limitation of the participation rate of the NHCE group.
So, what’s the trade off? In order to satisfy a safe harbor election, the employer is required to comply with safe harbor standards which include the following:
Does your plan include an automatic enrollment feature? If so, a modified version of the safe harbor plan is available for you. The rules for so-called Qualified Automatic Contribution Arrangements (QACA) are similar to the regular safe harbor rules, except that the QACA matching requirement is 100% of the first 1% of compensation deferred, plus 50% of the next 5% of compensation deferred (maximum match of 3.5%). In addition, safe harbor contributions under the QACA must be 100% vested after two years of service rather than the immediate vesting required of traditional safe harbor plans. The participant notice must contain additional information describing the automatic enrollment features.
A safe harbor design is an excellent way for many employers to get the most out of their 401(k) plans. By eliminating nondiscrimination testing, all employees can contribute up to the annual deferral limit and not be concerned about the possibility of refunds after year-end. If you think a safe harbor option is right for your plan, contact us.
On Sept. 23rd, the IRS published a final rule that relaxes several existing restrictions on participant hardship distributions from defined contribution plans.
Some of these changes are mandatory, requiring employers to make the changes by Jan. 1st, 2020, while others are optional. Though the IRS had issued the proposed regulations in 2018, the final regulations clarify a few key provisions:
For plan sponsors who use “pre-approved” plan documents for their 401(k) plans, the due date to amend your plan for the new regulations is the same as the tax filing deadline (including extensions) for the year in which the provisions become effective. For example, if the new rule is effective on January 1st, 2020 for a plan sponsor with a calendar fiscal year, the due date for amending the plan is the due date of the plan sponsor’s 2020 return including extensions. Regardless of the amendment date, compliance must begin on January 1st, 2020. For those who maintain individually designed plans, the deadline will be December 31st, 2021 regardless of plan year.
Plan Sponsors that took action on the proposed regulations should review their plan and operational processes to ensure compliance with the new rules and can contact us with any questions.
1st: Participant Notices – Annual notices due for Safe Harbor elections, Qualified Default Contributions (QDIA), and Automatic Contribution Arrangements (EACA or QACA).
31st: Participant Notices – Annual notices due for ERISA 404(c) and Fee Disclosure.
31st: Discretionary Amendments – Deadline to adopt discretionary plan amendments for calendar-year plans. If changes have been made to your retirement plan this year, the amendment documenting this change must be signed by the last day of the plan year in which it became effective.
31st: Required Minimum Distributions – Participants who have attained age 70 1/2, and have begun receiving distributions from their account, are required to receive a distribution each year prior to December 31st.
31st: IRS Form 945 – Deadline to file IRS Form 945 to report income tax withheld from qualified plan distributions made during the prior plan year. The deadline may be extended to February 10th if taxes were deposited on time during the prior plan year.
31st: IRS Form 1099-R – Deadline to distribute Form 1099-R to participants and beneficiaries who received a distribution or a deemed distribution during prior plan year. A deemed distribution can occur if a participant fails to make timely loan repayments.
31st: IRS Form W-2 – Deadline to distribute Form W-2, which must reflect aggregate value of employer-provided employee benefits.
On November 6th, 2019, the IRS announced the cost of living adjustments affecting the dollar limitations for retirement plans.
Contribution and benefit increases are based on a calculated change in the Consumer Price Index and are intended to allow participant contributions and benefits to keep up with the “cost of living” from year to year. Here are some highlights from the 2020 changes:
|Annual Plan Limits||2020||2019||2018|
|Contribution and Benefit Limits|
|Elective Deferral Limit||$19,500||$19,000||$18,500|
|Annual Contribution Limit||$57,000||$56,000||$55,000|
|Annual Contribution Limit including Catch-Up Contributions||$63,500||$62,000||$61,000|
|Annual Benefit Limit||$230,000||$225,000||$220,000|
|Maximum Plan Compensation||$285,000||$280,000||$275,000|
|Income Subject to Social Security||$137,700||$132,900||$128,400|
|Key EE Compensation Threshold||$185,000||$180,000||$175,000|
|Highly Compensated EE Threshold||$130,000||$125,000||$120,000|
|SIMPLE Plan Elective Deferrals||$13,500||$13,000||$12,500|
|SIMPLE Catch-Up Contributions||$3,000||$3,000||$3,000|
|Individual Retirement Account (IRA)||$6,000||$6,000||$5,500|
|IRA Catch-Up Contribution||$1,000||$1,000||$1,000|
The increases in the annual limits allow employers and participants to contribute more toward retirement.
Domestic Equity markets posted modest gains during the third quarter of 2019 with the S&P 500 Index increasing 1.7%. Market volatility persisted throughout the quarter with major domestic indices reaching all-time highs in July before reversing in August on the back of geopolitical issues and escalating trade tensions. Trade pressures eased in September and equities rebounded, leaving the S&P 500 Index up 20.6% year-to-date – its best start to a year in over two decades.
Large-cap stocks once again outperformed their small-cap counterparts during the quarter, with the Russell 1000 Index gaining 1.4% and the Russell 2000 Index declining 2.4%. Income generating stocks were the top performers during the quarter with the Utilities, Real Estate, and Consumer Staples sectors returning 9.3%, 7.7%, and 6.1%, respectively. Energy was once again the worst performing sector, down 6.3% during the quarter and down over 19% on a one-year basis. Oil prices have continued to decline due to slowing economic growth, despite a brief spike in September after a drone attack on two major Saudi oil facilities.
Equity markets outside of the U.S. posted modest losses on an aggregate basis during the third quarter. Japanese markets were among the best performers, with the MSCI Japan Index returning 3.1%, due in part to the result of the Upper House elections in July, which provided a platform for policy stability. The MSCI Europe Index fell 1.8% as the Euro depreciated against the dollar, economic growth continued to slow, and fears over a no-deal Brexit and global trade tensions intensified. Emerging markets were some of the worst performers with the MSCI EM Index down 4.2% during the quarter, as investors moved to less risky assets and emerging market currencies struggled. Among the emerging markets, Argentina was one of the worst performers with shares falling almost 47% after market-friendly President Marci lost the nation’s presidential election.
In line with their dovish outlook signaled earlier in the year, the Federal Open Market Committee (“FOMC”) cut rates by 25 basis points at both their July and September meetings, leaving the target range for the federal funds rate at 1.75% to 2.00%. Fed Chairman Jerome Powell failed to provide conclusive guidance for the FOMC’s next move, but markets expect one more 25 basis point rate cut by year end. The yield on the 10-year Treasury fell from 2.02% to 1.47% in August – its lowest level since July 2016 – before rebounding somewhat, ending the quarter at 1.68%. The yield curve for 2- and 10-year Treasuries inverted for the first time since 2007 as the yield on 2-year Treasuries briefly surpassed that of 10-year Treasuries towards the end of August.
The initial estimate of third quarter gross domestic product (GDP) was for 1.9% growth, beating market expectations of 1.6%. Personal consumption expenditures, government spending, and a rebound in exports were the largest drivers of growth. On the other hand, a rise in imports and a sharp decline in business investment as companies spent less on equipment and nonresidential structures detracted from GDP. Consumer and business confidence indices declined significantly in August before rebounding in September. International economies continued to slow as trade and political tensions persisted.
The U.S. unemployment rate fell from 3.7% to 3.5% during the third quarter – its lowest level since December 1969 – while the labor force participation rate increased from 62.9% to 63.2%. The U.S. economy added an average of 157,000 jobs per month during the quarter, the lowest quarterly gain since 2017. The September Jobs Report saw continued increases in employment from the health care and professional and business services sectors.
The year-over-year headline inflation rate increased marginally from 1.6% to 1.7% during the quarter, with increased food prices helping to offset declining energy prices. During the same period, core inflation, which excludes food and energy, increased from 2.1% to 2.4% with upward pressure in transportation services, medical care services, and shelter.