Employer Guide to Setting Up a 401(k) Plan

A 401(k) plan is one of the most valued employee benefits and can be a powerful recruiting and retention tool. However, establishing and maintaining a plan involves significant legal and administrative responsibilities under ERISA, the Internal Revenue Code, and Department of Labor regulations.

Choosing a Plan Type

Several 401(k) plan designs are available:

• Traditional 401(k): Allows employer and employee contributions with annual nondiscrimination testing to ensure the plan does not disproportionately benefit highly compensated employees
• Safe Harbor 401(k): Requires specific employer contributions (either matching or nonelective) in exchange for exemption from most nondiscrimination testing
• SIMPLE 401(k): Available to employers with 100 or fewer employees, with simplified administration and required employer contributions
• Roth 401(k): A feature that can be added to any plan type, allowing employees to make after-tax contributions that grow tax-free

Safe Harbor plans are popular because they eliminate the risk of failing nondiscrimination tests, which can require returning contributions to highly compensated employees.

Setting Up the Plan

The process of establishing a 401(k) involves several steps:

• Select a plan provider (recordkeeper, third-party administrator, and investment platform)
• Adopt a written plan document that meets IRS requirements
• Establish a trust fund to hold plan assets
• Develop an investment policy and select investment options
• Enroll eligible employees and distribute summary plan descriptions
• Set up payroll deductions and contribution remittance processes

Employer Responsibilities

Once the plan is established, the employer has ongoing duties:

• Fiduciary duty: Plan fiduciaries must act solely in the interest of plan participants, with the care, skill, prudence, and diligence of a prudent person
• Timely deposit of contributions: Employee deferrals must be deposited as soon as they can be reasonably segregated from the employer's general assets, but no later than the 15th business day of the following month (small plans) or within a few days (DOL expectation for larger plans)
• Annual testing: Unless operating a Safe Harbor plan, annual nondiscrimination testing (ADP/ACP tests) is required
• Form 5500 filing: Annual return filed with the DOL reporting plan financial information, generally due seven months after the plan year ends
• Summary Annual Report: Must be distributed to participants annually
• Fee disclosure: Provide fee and investment information to participants as required by DOL regulations

Common Compliance Issues

Frequent 401(k) compliance problems include:

• Late deposit of employee contributions (one of the DOL's most frequent enforcement findings)
• Failure to follow the plan document (such as applying incorrect eligibility rules)
• Operational errors in calculating contributions or applying vesting schedules
• Failure to provide required notices on time
• Inadequate monitoring of investment options and plan fees
• Failing to update the plan document for required law changes

The IRS Employee Plans Compliance Resolution System (EPCRS) provides methods for correcting many common errors. Voluntary correction is less expensive and disruptive than correction after an audit.

Selecting and Monitoring Investments

As a plan fiduciary, you have a duty to prudently select and monitor investment options:

• Offer a diverse range of investment options across different asset classes
• Consider fees and expenses associated with each option
• Review investment performance regularly and replace underperforming options
• Consider including target-date funds as a default investment option
• Document your selection and monitoring process
• Consider using an independent investment advisor to support fiduciary decisions