Facts
We are planning to establish a new 401(k) plan for our employees. Between getting set up with a recordkeeper, selecting the investment menu, working with our TPA to prepare the plan documents and getting the employees enrolled, there are a lot of moving parts to coordinate. We want to launch the plan as soon as possible, but we also don’t want to back ourselves into a corner if we cannot get everything set up in time.
Question
How precise do we need to be with the start date of the plan? Is it a big deal if we choose a date but end up running a few pay periods behind for actually starting employee deferrals?
Answer
This is a question that comes up quite often for exactly the reasons you mention. The good news is that you have flexibility in setting the start date for the plan. To avoid having to prorate many of the annual contribution limits, it is common practice to make the overall plan effective on the first day of the current year and then use a delayed effective date for employee 401(k) contributions. For example, the plan document might say that the plan is effective on January 1, 2018, and that 401(k) deferrals are effective on May 1, 2018.
Although there is flexibility in setting that May 1st date, once it is set, you are required to stick to it. If May 1st arrives and you are not ready to withhold employee deferrals, it is considered to be a failure to operate the plan consistently with the plan documents. That often means the company is on the hook to make corrective contributions for the so-called missed deferral opportunity for each pay period that deferrals are not started. You don’t want to start off with your brand new plan having to make corrections.
In order to avoid negative employee PR and to not have to make those corrective contributions, it is a good idea to set the deferral start date in the plan document far enough out that you can easily meet it. It doesn’t have to be the first day of a month. Instead, it could be any pay date. Assuming semi-monthly pay dates in our above example, it would be fine to set the deferral start date at May 15th instead of waiting until June 1st.
A couple notes of caution are in order. If you are setting up a safe harbor 401(k) plan, then deferrals have to be available for at least three months in the first year. That means you cannot push the deferral start date any later than October 1st (assuming a calendar year plan). If you won’t be ready to implement the deferral feature by that date, then the safe harbor features cannot be applied until the subsequent January 1st.
If the plan will not be a safe harbor plan, you'll also want to make sure the deferral start date is early enough in the year for employees to defer enough to pass the nondiscrimination test known as the ADP test. It limits the highly compensated employee deferrals based on how much the non-HCEs contribute. Starting deferrals on December 1st may allow the higher paid people to maximize their deferrals, but if the non-HCEs are not in a financial position to defer very much in that single month, then the plan will likely fail the ADP test, requiring the HCEs to be refunded a potentially significant portion of their contributions.
Your best bet is to make sure every member of your plan service team—TPA, investment advisor, recordkeeper, etc.—all work together to help you coordinate all the moving parts and settle on a start date that addresses all of these concerns.
For more information on retirement plan design, visit our Knowledge Center here.
