The Form 5500 filing season is behind us, but self-directed brokerage accounts haven’t gone away. And neither have the issues Plan Sponsors need to deal with.

I wrote about self-directed brokerage accounts ten years ago. They’re still around, and so are many of the same issues employers need to consider when offering them.

What Is a Self-Directed Brokerage Account?

A Self-Directed Brokerage Account, or SDBA, allows a participant to invest some or all of a retirement plan account outside the Plan’s regular investment menu.

At the time of my earlier article, I noted that the driving force behind adding an SDBA was often a business owner or important executive with a large account balance who wanted investment choices beyond the Plan’s regular menu.

And those participants have, as we say in Chicago, clout.

Ten years later, the investment choices have changed. The basic issues for employers haven’t.

More Choice Requires Limits

SDBAs aren’t necessarily a bad Plan feature. For sophisticated participants, access to a broader universe of investments can be attractive.

But there’s an important distinction between giving participants investment discretion and giving up Plan oversight.

A brokerage window can give participants access to hundreds or even thousands of investments beyond the Plan’s regular investment menu. That doesn’t mean every investment available through the brokerage platform has to be available through the Plan.

The employer should determine what types of investments will be permitted, whether any should be restricted, how much of a participant’s account can be invested through the brokerage window, and whether access will be available to all participants.

Those decisions should be intentional, not simply whatever the brokerage provider happens to permit.

Start With the Plan Document

Does the Plan document permit self-directed brokerage accounts? Who is eligible to use them? Can the entire participant account be transferred to the SDBA, or only a portion?

Then look at the actual operation of the Plan. What does the recordkeeper permit? What does the brokerage provider permit? Are those provisions consistent with the Plan document and the employer’s intentions?

The answer shouldn’t be, “We’ve always had it.”

Understand the Fees

The participant may choose the investments, but the employer selected the Plan’s service providers and approved the brokerage arrangement.

What does the brokerage account cost the participant? What compensation does the provider receive? Are there other fees or compensation associated with investments available through the brokerage window?

For the employer, the practical point is straightforward: understand who is getting paid, how much they are getting paid, and why.

Put It in Writing

The employer should have a documented process for how the SDBA fits within the Plan. That process might address who can use it, how much can be invested through it, restricted investments, fees, participant disclosures, and responsibility for reviewing the brokerage provider.

Whatever is put in writing should reflect how the Plan actually operates.

Review the Plan

Plan provisions have a way of becoming part of the furniture. Someone made a decision years ago. The provision was added. Participants used it. And unless something went wrong, nobody had much reason to revisit it.

An SDBA shouldn’t be treated that way.

The Plan Review should include the brokerage window. Does it still serve its intended purpose? Are the fees reasonable? Are the investment restrictions still appropriate? Have new types of investments become available? Do the Plan’s written provisions and procedures still match actual operations?

Those are not questions that should wait until there is a problem.

The Takeaway

Self-directed brokerage accounts can be a valuable Plan feature. They can provide participants with investment flexibility well beyond the Plan’s regular investment menu.

But self-directed doesn’t mean the employer should stop paying attention.

Establish the rules, understand the fees, document the process, and include the SDBA in the Plan Review.

Roth describes how the contribution is taxed; it does not describe what type of contribution it is.

When people hear “Roth” in a 401(k) plan, they often think of an employee choosing to make a Roth 401(k) contribution instead of a traditional pre-tax contribution.

That’s still true. But today, an employer profit-sharing contribution can also receive Roth treatment if the plan permits it and the employee makes the election.

So, an employee could have both a Roth 401(k) contribution and a Roth profit-sharing contribution. Both are Roth. But they are not the same contribution.

Employee Money and Employer Money

A Roth 401(k) contribution is an employee contribution. The employee elects to have money deducted from pay and contributed to the plan. It is included in the employee’s taxable wages and is subject to Social Security and Medicare taxes.

A Roth profit-sharing contribution is an employer contribution. The employer contributes the money to the plan, and the employee elects Roth treatment. It is taxable to the employee, but it is not subject to Social Security and Medicare taxes. The taxable amount is reported separately to the employee.

Keep the Contributions Separate

Because both contributions are called “Roth,” it might seem logical to combine them when sending money to the plan. Don’t. One is an employee 401(k) contribution. The other is an employer profit-sharing contribution. They need to be separately identified and properly recorded by the plan’s recordkeeper.

The Takeaway

A Roth 401(k) contribution and a Roth profit-sharing contribution may share the same tax label, but they are different contributions. One comes from the employee. The other comes from the employer. They are contributed, reported and taxed differently.

Roth tells you how the money is taxed. You still need to know what kind of money it is.

Recent legislation now requires that automatic enrollment be part of most new 401(k) and 403(b) Plans. But making it work requires coordination.

That coordination starts with understanding how the process works.

How Automatic Enrollment Works

Automatic enrollment has been part of retirement Plan design for many years as a way to encourage more employees to save for retirement. Instead of requiring an eligible employee to make an affirmative election to contribute, the employee is automatically enrolled unless he or she elects otherwise

The specific requirements, including applicable exceptions, depend on the Plan.

Contribution Rates

The initial contribution rate must be at least 3% but not more than 10% of compensation. The Plan determines the initial rate within that range.

Automatic enrollment can also include automatic escalation if provided for in the Plan. The employee’s contribution rate generally increases by one percentage point each year until it reaches the percentage established by the Plan within the permitted range.

The employee remains in control. An automatically enrolled employee can elect a different contribution rate or opt out of the Plan.

Follow The Process

Automatic enrollment isn’t a one-time enrollment event. It is an ongoing process involving eligibility, employee elections, payroll deductions, transmitting funds to the recordkeeper, confirmations, and annual increases.

This process requires coordination and communication among the employer and its service providers: the TPA, the financial advisor, and the recordkeeper. Each party has to understand its role, what information it needs, where that information comes from, and what happens next.

Fund Accounting Adds Another Layer

For many non-profit employers, fund accounting adds another dimension. Payroll may be allocated among different programs, departments, grants or funding sources, and an employee may be paid from several sources during the same payroll period.

Making Automatic Enrollment Work

The key to making it an efficient and accurate process is establishing that process before automatic enrollment begins. Here are some basic questions that need to be answered.

• Who determines when an employee becomes eligible?
• How does that information get to payroll?
• Who initiates the transfer of funds?
• How does the recordkeeper know how to allocate them?
• And who confirms that the transaction was completed correctly?

Mistakes Can Happen

Automatic enrollment is a transaction-intensive process involving multiple systems and service providers. Even with the best procedures, mistakes can and do happen.

The IRS recognizes that retirement Plan operational errors occur and has established procedures for correcting them which include automatic enrollment mistakes.

But correction, of course, begins with identifying the error. This means that regular confirmation and reconciliation, if necessary, must be an essential part of the end-to-end process.

Technology can drive the automatic enrollment process, but effective oversight remains a human job.

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Until recently, participants receiving matching and nonelective contributions could only have had those contributions treated as pre-tax – not subject to withholding for federal income tax, Social Security or Medicare tax.

That’s changed. Recent retirement law changes permit participants to elect to have employer matching and nonelective contributions treated as Roth contributions instead of the traditional pre-tax employer contribution. This means:

• The participant pays income tax now on the contribution.
• Future qualified distributions of that contribution and its earnings are tax-free.
• The employer still deducts the contribution as a business expense.

How Does It Work?

1.  Plan Document. The Plan must specifically permit designated Roth employer contributions. Most existing documents do not unless they have been amended.

2. Participant Election. The participant must make an affirmative election. The employer cannot automatically treat employer contributions as Roth.

3. Contributions Must Be Fully Vested. Only contributions that are 100% vested when allocated may be designated as Roth employer contributions. If the contribution is subject to a vesting schedule, it cannot be treated as Roth until vested.

4. Recordkeeper Support. The recordkeeper must be able to maintain a separate Roth employer contribution source. Many systems have only recently added this capability.

5. Tax Reporting. Unlike Roth salary deferrals, these contributions are generally reported on Form 1099-R for the year they are allocated to the participant’s account, even though no cash is distributed. The amount is taxable in that year.

6. Payroll Coordination. Payroll processors need to know the taxable amount so it is reflected correctly for the participant’s tax reporting. Although the contribution is taxable income, it is generally not subject to federal income tax withholding, Social Security, or Medicare withholding merely if it is designated Roth.

What Are the Pros and Cons?

It may appeal to participants who:

• Expect to be in a higher tax bracket in retirement.
• Want to build Roth assets more quickly than salary deferral limits alone allow.
• Have cash available to pay the current tax.

But some employers may not adopt it.

• It increases administrative complexity.
• Employees need education about the tax consequences.
• Many employees prefer to defer taxes rather than pay them immediately.

Moving Forward

Retirement planning is rarely about finding one right answer. It’s about understanding the choices available and selecting the ones that are the best fit. Roth employer contributions provide a unique opportunity for employers and participants to work together to make informed retirement planning decisions.

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When a tax-exempt organization decides to establish a retirement Plan, the starting point is usually whether to adopt a 401(k) Plan or a 403(b) Plan.

While that’s an important decision, it may not be the best place to start.

Most discussions begin by comparing the features of 401(k) and 403(b) Plans. While those comparisons are helpful, they don’t necessarily lead to the best decision.

Instead, start by asking a different question:

What are we trying to accomplish?

No two organizations are exactly alike. Their mission, size, location, workforce, financial resources, administrative resources, and long-term objectives all influence which retirement Plan is the better fit.

Once those objectives are clear, the choice between a 401(k) Plan and a 403(b) Plan often becomes much easier.

The retirement Plan should support the organization—not the other way around.

That means stepping back before comparing Plan provisions and asking questions such as:

• Why are we establishing a retirement Plan?
• What do we want this Plan to accomplish for our employees?
• How important is administrative simplicity?
• Will this Plan support our organization as it grows and changes?
• Will this decision still make sense five or ten years from now?

Only after answering those questions does it make sense to compare providers, investment options, Plan provisions, and fees.

There is no universally “best” retirement Plan. There is only the retirement Plan that is the best fit for your organization.

A thoughtful decision-making process won’t guarantee a perfect outcome. It will, however, significantly increase the likelihood of selecting a retirement Plan that supports the organization’s mission while helping its employees prepare for retirement.

Every employer maintaining a pre-approved defined contribution retirement plan—including 401(k) and 403(b) Plans will need to update their documents by December 31, 2026 to maintain reliance on IRS approval.

401(k) Plans will need to adopt amendments reflecting SECURE 2.0, the most significant retirement plan legislation enacted in many years.

403(b) Plans will need to be restated for what is called Cycle 2, the IRS requirement that 403(b) Plan documents be restated updated to reflect regulatory and legislative changes over the last several years.

While the immediate objective is compliance, the amendment process also provides an opportunity to review the effectiveness of your retirement plan.

Too often, Plan Sponsors view required plan amendments and restatements as simply an administrative exercise — review the documents, sign the required paperwork, distribute participant communications, and move on.

While that approach satisfies the technical requirement, it may overlook an opportunity to review and improve important aspects of your retirement plan, including:

• Governance and fiduciary oversight
• Service providers and service delivery
• Fees and expenses
• Participant outcomes
• Plan design
• Administration and operations

The following six questions can help you determine whether your retirement plan continues to meet the needs of your organization and employees.

1. Are We Meeting Our Fiduciary Responsibilities?

Fiduciary responsibility begins with having a prudent process for making decisions and monitoring a 403(b) Plan. The amendment process provides an excellent opportunity to review governance procedures, committee structures, and the responsibilities assigned to internal personnel and service providers.

2. Are We Receiving the Type of Service We Need?

The needs of an organization change over time. Employee demographics change. Regulations change. Service providers change.

The amendment process provides an opportunity to determine whether the current service model for your 403(b) Plan continues to meet the organization’s needs and objectives.

3. Are We Receiving Value for the Fees Being Paid?

Plan Sponsors should understand what services they receive and what those services cost. Reviewing and benchmarking the expenses of a retirement plan can help determine whether fees remain reasonable and whether participants are receiving appropriate value for those costs.

4. Are We Helping Participants Prepare for Retirement?

A successful retirement plan is measured by more than compliance. Participation rates, deferral rates, employee education, and participant communications all affect retirement readiness.

The amendment process provides an opportunity to evaluate whether your retirement plan is helping participants achieve their long-term retirement goals.

5. Are We Taking Advantage of Available Plan Design Opportunities?

SECURE 2.0 provides Plan Sponsors with additional design options. While not every provision is appropriate for every organization, the amendment process provides a natural opportunity to evaluate whether changes to your retirement plan could improve participant outcomes.

It is also an opportunity to determine whether your retirement plan continues to support the organization’s objectives and workforce demographics.

6. Is Your Retirement Plan Being Operated in Accordance with the Plan Document?

Many compliance issues result not from defective documents, but from operational practices that differ from the written terms of the plan.

Eligibility, contributions, loans, hardship distributions, and administrative procedures should all be reviewed periodically to confirm that the operation of the plan remains consistent with its governing documents.

The Opportunity

401(k) and 403(b) Plan Sponsors will need to adopt amendments and restatements respectively by December 31, 2026.

This is an opportunity to use these compliance requirements as a catalyst for a review of your retirement Plan.

The question is whether you will use the process to improve your retirement plan.

Details to follow.

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Employers who have adopted a pre-approved Pension Plan – either traditional Defined Benefit or Cash Balance – must restate their plans by March 31, 2025 to stay in compliance with the Internal Revenue Code (“Code”) and Internal Revenue Service (“IRS”) regulations.

If you’re not part of our retirement plan world, both the law and regulations can be complicated and confusing. To help you understand what’s required and how to take advantage of the required Restatement process, here is a Plain Language explanation in a Question and Answer format.

Q. Why do I need to restate my Defined Benefit Pension Plan or Cash Balance Pension Plan at this time?

A. The IRS established a system that requires employers who have adopted a pre-approved retirement Plan to restate their Plans once every six years to reflect changes in the Code and IRS regulations. This Restatement is called Cycle 3 because it is the third time the IRS has used this system.

Q. How will the Restatement process be handled?

A. Our firm like other retirement plan service firms sponsors a series of retirement Plans for which favorable approval has been received from the IRS. Using a pre-approved Plan can provide employers with an efficient and cost-effective retirement plan document rather than having a document that is individually drafted by an attorney.

Q. What will change in the document?

A. As mentioned above, pre-approved Plans must include the requirements from the prior laws, new laws added by Congress and regulations issued by the IRS. Prior amendments that were executed previously are also included. These are called “Good Faith Amendments” and are not totally new, but up to now have not been formally approved by the IRS.

Q. Do the Cycle 3 documents include SECURE, CARES and SECURE 2.0 language?

A. No. Because these Acts were signed into law after the deadline for the submission of Cycle 3 Pension Plan documents for IRS approval. Instead, the required language for SECURE and CARES is in a separate document addendum. A SECURE 2.0 addendum/amendment will be available after the IRS reviews and approves the language.

Q. Can employers rely on the IRS Opinion Letter?

A. Yes. But it is important to note that pre-approved Plans are only approved as to form. They still must be operated in accordance with the Code and IRS regulation to enjoy favorable tax treatment.

Q. Why does the Restatement consist of?

A.  Our Restatement process consists of the required documents and resources to help the fiduciaries manage their Plans more effectively and efficiently. We refer to it as our “Restatement Portfolio” and includes the following:

Q. What is the Operational Checklist mentioned above?

A.  Several operational provisions that were part of the former Plan document have been moved into a separate Operations Checklist. They are not required to be part of the Plan document. We have included them as a supplement to the Plan document and can be changed without the need for a Plan amendment

Q. Are there any special considerations when replacing one Plan document with another?

A. Yes. Special care must be taken to ensure that certain benefits called “protected benefits” are not unintentionally eliminated or reduced. Protected benefits include forms of distributions such as lump sums and annuities and timing of distributions such as an early retirement provision.

Q. Can the restatement process be used to make changes to the Plan?

A. Most certainly. the Restatement process provides the opportunity to review the Plan to determine if there are provisions that better align with Plan Sponsor objectives and better serve the employees. Plan changes can be efficiently made as part of the Restatement.

Q. Why are we discussing the Restatement now if the deadline is March 31, 2025?

A. The March 31, 2025 deadline may seem like a long time away. But in order to ensure that there is sufficien time to review the Plan as discussed above, we’re beginning the Restatement process now.

Q. Does a terminating Plan need to be restated?

A. Practically speaking, yes.  Plans that are terminating must be updated at the time of termination to reflect all applicable qualification requirements then in effect.  This means the Plan must have all relevant amendments at the termination date. Using a pre-approved Plan is the most efficient method of accomplishing this.

Q. Is the Restatement mandatory?

A. Yes.  A retirement Plan keeps its tax-favored status only by maintaining a document with language that satisfies the law and regulations and operates under the terms of such document.  Failure to restate the document before the March 31, 2025 deadline can result in disqualification of the Plan and/or significant penalties.

Q. What happens if i fail to restate my Plan on a timely basis?

A. If you miss the deadline for restating your Plan, then you can avoid Plan disqualification by using an IRS correction program. If the IRS discovers the missed deadline before you take corrective action, the cost associated to update the Plan will be significantly higher. And starting this year they will. Form 5500 for 2023 now requires employers to provide the serial number of the pre-approved Plan they have adopted. It’s safe to say that the IRS will be looking for the right response.

Q. What does it cost for the Plan Restatement?

A.  The cost of restating a Plan will vary depending on such factors as the type of Plan, provisions, and administrative requirements. No two Plans are exactly alike so an appropriate fee is based on the specific facts and circumstances. The cost to restate the Plan for IRS compliance may be paid by the employer or from Plan assets if permitted by the Plan document.

KEY TAKAWAY

It is the responsibility of the Plan fiduciary to ensure that the Plan is updated and signed by the  March 31, 2025 deadline. Because the Restatement process can be time consuming, it is important to begin Planning to ensure the Restatement deadline is met. And as mentioned above, it’s now a compliance question on Form 5500.

Here’s why we think so.

Since the passage of ERISA in 1974, retirement plan legislation has been a series of technical and tax-related changes. The Revenue Act of 1978 started out the same way with its focus on:

• Increasing economic growth through income tax reductions to stimulate consumer and investment spending, and

• Improving equity in the tax system and simplifying it.

Sometimes during the legislative process an unrelated provision is added to the law. That’s what happened here. Section 401(k) found its way into the Internal Revenue Code. In one fell swoop, this new Code Section replaced what was then the primary employee retirement saving vehicle, “After-Tax Thrift Plans”, which were retirement savings plans to which employees made contributions on an after-tax basis.

This new Section 401(k) allowed employees to make those contributions on a pre-tax basis. It also provided a comfort level to employees that their accounts would not be locked up until the traditional age 65 retirement age. It also permitted access to those funds with in-service distributions at age 59½, upon severance from employment, or because of hardship or disability.

SECURE 2.0 which Congress passed 46 years later went significantly further. Passed at the tail end of 2022 as an extension of the 2019 SECURE Act, there were 92 provisions in approximately 400 pages with four major themes:

• Expanding participant coverage.

• Encouraging retirement savings.

• Helping participants preserve income.

• Simplifying retirement plan rules and administrative procedures.

SECURE 2.0 is also different for two other reasons.

First, there are optional and mandatory provisions. A plan sponsor can adopt the optional ones, or not, based on the plan’s objectives. The mandatory provisions, on the other hand, must be timely adopted by plan amendments to maintain the plan’s tax qualification.

Second, the effective dates of the various provisions are staggered. Provisions are effective in 2023, 2024, 2025, and beyond. These staggered effective dates provide breathing room for the IRS to provide guidance, for the retirement plan industry to make the necessary changes to administrative systems and documents, and for plan sponsors to make the best decisions for their retirement plans.

Details to follow.

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Kids will outgrow their clothes. Sometimes that happens with retirement plans.

If you have a SIMPLE IRA, it may have fit in the beginning. But if you want to change to a 401(k) plan in 2024, you need to take action by November 2. That’s the date that employers must provide notice to their employees that 2023 will be the last year for the SIMPLE IRA, and that it will be replaced by a 401(k) plan in 2024.

But keep reading because a new tax law which providres for a mid-year replacement is discussed later.

Reasons to Change

A SIMPLE IRA is relatively easy and inexpensive to administer. 401(k) plans, on the other hande, are more complicated and expensive but have features that businesses (and business owners) can take advantage of. 401(k) plans can:

• Provide larger tax-deductible contributions.
• Favor owners and highly compensated employees.
• Require more employment service to be eligible to participate.
• Provide a graded vesting schedule.
• Allow for plan loans.
• Provide better creditor protection.
• Be able to buy tax-deductible life insurance.

Extended Deadline

As mentioned above, the November 2 deadline has been extended. Starting in 2024, the new SECURE 2.0 tax law allows an employer to replace a SIMPLE IRA mid-year with a safe harbor 401(k) plan. The 401(k)-replacement plan must be effective as of the termination date of the SIMPLE IRA. There are two planning considerations to the new law:

401(k) Deferral Limit. Employees would be restricted to an aggregate elective deferral limit including catch-up contributions during the replacement year. The limit is based on the number of days covered in each plan.

Rollovers/Transfers. The tax rules regarding a rollover or transfer from a SIMPLE to another qualified retirement plan have stayed the same. In general, an employee cannot transfer money tax-free to a 401(k) plan during the 2-year period beginning when the employee first participated in the SIMPLE. The 2-year period begins on the first day on which the employer deposits contributions in the employee’s SIMPLE.

The Right Answer

There isn’t one. Just like the visual metaphor used for this blog post, it’s whatever fits best.

The deadline for restating a 401(k), profit sharing, or money purchase pension plan has come and gone.  So, what can an employer do? It was, after all, the employer’s responsibility to ensure that the plan was updated and signed by July 31, 2022.

But if an employer did miss that deadline, there is a Plan B. But first let’s put July 31, 2022, into context. That’s the date the IRS required pre-approved plans to be updated for the last 6 years of legislative and regulatory changes.

It’s referred to as a “Cycle 3 restatement” in the retirement plan world and allows the employer to have “reliance” that the document meets the current requirements of the law and regulations. Here is a link to our FAQs from last year that will bring you up to date.

So what’s the impact on an employer’s plan that didn’t restate its plan by the July 31, 2022 deadline? It’s a good news-not so-bad news situation.

The good news is that the IRS does not consider that the failure to timely restate the plan will itself disqualify it from favorable tax treatment.

The not-so-good news is that the failure transforms that pre-approved plan into an individually designed plan upon which the employer can no longer rely as a qualified plan. The Plan B mentioned above would be for the employer to adopt corrections under the IRS Self-Correction Program and consider whether to obtain formal approval through its Voluntary Correction Program.

You may be wondering if there is a Plan B, is there also a Plan C? Not exactly, and it’s certainly not voluntary. It’s the IRS’ Audit Agreement Closing Program (“Audit CAP”) which is the end result of a plan audit. If the IRS finds the plan to be non-compliant, the employer would be required to submit an updated plan to avoid disqualification. The cost of which would be significantly more than if the missed deadline was dealt with on a voluntary basis.

The takeaway should be obvious: Contact them before they contact you.

Photo Credit: © Can Stock Photo / bdspn