Offering a retirement plan isn’t a decision that your business owner clients take lightly. A lot of time and effort goes into researching options and designing a plan. Once they’ve made the decision, even more time and money go into implementing and administering the plan.
With so much invested in their employee retirement plans, your clients want to see them succeed. Not all plans are successful, though. Here are three unexpected reasons that retirement plans fail:
1. Market And Company Changes
If your client has had their retirement plan for a while, when is the last time they reviewed it? Have they taken the time to update it as the size and demographics of their workforce have changed?
Shrinking companies often find that they no longer need a large pension plan. These plans slowly transform from a benefit to a burden as the workforce is reduced. Changes in the age of employees can affect the company’s required contributions in some plans, making them untenable. Such company changes can make a once thriving retirement plan fail.
One of the main reasons your client even offers a retirement plan is to attract and retain talent. As markets shift, plans can become outdated and fail to entice top performers. Plan sponsors need to make sure their plans keep pace with their market and industry in order to be successful.
2. Lack Of Employee Participation
You would think that everyone would jump at the chance to save for retirement pre-tax. However, the Department of Labor reports that about 30% of eligible employees don’t participate in company 401(k) plans. Participation rates are lower for younger employees and those that get paid less.
Younger employees often think that retirement is so far in the future that they have plenty of time before they need to save. They also may be focusing on more pressing large expenses, such as weddings, graduate school, and first homes. Employees with smaller salaries naturally have less money to set aside for retirement. Many people, regardless of age or income, don’t participate because they are intimidated by their lack of knowledge to choose investments.
Lack of employee participation will harm a retirement plan in two ways. First, if current employees aren’t interested, prospective employees won’t be either. A low participation rate does not bode well for a plan’s ability to attract talent.
Second, lack of participation, especially by those lower on the pay scale, can cause a plan to fail compliance testing. Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) testing require enough rank-and-file employees to participate for the highly compensated employees (like your clients) to be able to participate or receive full benefits. If a plan cannot pass compliance testing, it will become disqualified and lose its tax-advantaged status.
3. Compliance Failures
As mentioned above, compliance failures are one of the quickest ways for a retirement plan to fail. When a plan fails to maintain compliance, the IRS revokes its qualified status. Without that status, neither the company nor the employees will receive tax advantages.
Laws and regulations surrounding retirement plans are constantly changing, so compliance is an ongoing process. Here are some of the most common compliance failures that companies experience:
- Failure to amend the plan in a timely manner to comply with changes to current law or regulatory guidance
- Failure to administer plan loans to participants in accordance with IRC §72(p) and IRS regulatory guidance
- Failing to follow plan documents in the administration of the plan’s eligibility, contribution, vesting or other significant operations
- Failure to pass the 401(k) ADP and ACP nondiscrimination tests
- Adopting a Safe Harbor plan to avoid the ADP and ACP tests and failing to make required Safe Harbor contributions
- Adopting a Safe Harbor plan to avoid the ADP and ACP tests and failing to give the required Annual Safe harbor Notice
- Making in-service distributions that are not allowed under the plan
- Failure to reinstate re-hired employees as plan participants within the time periods required by the plan document and the Internal Revenue code
- Failure to make the required minimum top-heavy contribution
- Contributing more than the amounts permitted under 10 Code §§402(g) and 415
How I Can Help
Keeping a retirement plan relevant and compliant is hard work. It requires specialized skills and knowledge that most business owners and their HR departments don’t have. That’s why so many people turn to pension specialists, such as myself, for help. I can help your clients maintain compliance, administer their plans, or simply answer their questions. If you have a business owner client that you think could benefit from an experienced retirement plan expert, email me today at firstname.lastname@example.org. Together we can make sure your clients’ retirement plans don’t fail.
About Kenny Phan
Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services, a 3(16) fiduciary. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses in the greater Phoenix area, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.