Just because you can doesn’t mean you should — a premise at the heart of an Oct. 24 session at the 2018 ASPPA Annual Conference that argued for caution in plan design changes, including student loan assistance programs.
Plan designs can cause difficulties for administrators, employers and third party administrators, observed Susan Diehl, President of PenServ Plan Services, Inc., and Steve Riordan, Director of Testing and Reporting Services for Fidelity Investments. And they reminded attendees of the need to keep in mind that in designing a plan and adjusting it, “Better never means better for everyone… it always means worse for some.”
Student Loan Repayment
Riordan noted that the IRS issued a private letter ruling (PLR) on Aug. 17 in which it said that a 401(k) plan can be amended to include a student loan benefit program. He included the caveat that PLRs may not be relief upon as precedent by others. PLRs do indicate, however, what the IRS is thinking about an issue and may be interesting to parties in situations similar to those a particular PLR addresses.
The IRS’ stance in the August PLR, Riordan said, means that student loan repayment (SLR) non-elective contributions made to the plan run by the particular employer in question would not violate the contingent benefit rule. “Student debt is astronomical,” noted Riordan, a reason that SLRs — and the PLR — have gained traction.
In such a program, once an employee enrolls in the program and makes student debt loan repayments, the employer makes SLR non-elective contributions to the 401(k) or 403(b) plan.The employee must pay at least 2% of compensation to the loan program to receive the SLR non-elective contribution of 5%. Employees participating in the program would still be eligible to defer to the 401(k) plan, but would be ineligible for the employer match.
So with popular demand, and the blessing of the IRS in the case of at least one SLR program, why is caution advisable? Riordan noted that SLR contributions are subject to all qualification requirements; however, he said that he is more concerned about coverage, nondiscrimination and contribution limits. Each component, he noted, is separately tested regarding coverage and nondiscrimination. If one population receives a match and the other receives a non-elective contribution, that increases the potential for coverage and non-discrimination failures, he warned. He also indicated that, while very few plans allow after-tax contributions, the plan the PLR addressed did allow after-tax and mentioned that will be an important consideration for coverage and non-discrimination.
Additional administrative duties are another consequence of offering an SLR program, Riordan said. The administrative complexities include that employees can opt in and out of program, so they may be eligible for non-elective contributions at times and eligible for a match at other times. He also expressed concerns regarding whether a student debt payment becomes part of the annual audit.
After the SLR discussion, Diehl and Riordan discussed caution regarding eligibility as it relates to plan design. Riordan said that one way sponsors address the administrative complexities is to adjust eligibility by excluding groups from participation. In addition, he noted, applying different eligibility provisions to different groups can reduce employer cost. But the silver lining loses some of its luster with Riordan’s observation that there are risks in turning to eligibility as an answer to administrative burdens: different eligibility by group may cause minimum coverage failures, and each contribution will need to satisfy either the ratio percentage test or the average benefits test.
Another plan feature that can be problematic, Diehl and Riordan said, are contribution formulas. Some plans place caps on highly compensated employee deferrals to ensure that the plan passes the ADP test. But it all boils down to how an employer wants to administer the plan, they said.
What are the pitfalls? Diehl and Riordan said that among them are that the cap may be too low, and that a cap of 15% may be more appropriate and would still allow HCEs to be close to the annual limit. Also, the way the formulas are used could prevent front-loading terminated HCEs but still allow for lower-paid HCEs to defer larger percentages. The plan may fail the ADP test but the two-step leveling method would refund the largest contributions first.
Additional complexities with contribution formulas are that providing different matching contributions to different groups can reward age, service or job classes, and non-uniform matching contributions may be subject to benefits, rights and features testing. Also, providing different non-elective contributions to different groups can sometimes have testing issues, but overall provide significantly larger benefits to a targeted group of employees closer to normal retirement age who typically are higher-paid.
Definition of Compensation
There are a variety complex factors to consider regarding compensation, including:
- determining who HCEs and key employees are;
- top-heavy contributions;
- determining Section 415 limits;
- non-discrimination testing; and
- safe harbor contributions.
The speakers cautioned that one of the failures the IRS identifies most often is the incorrect use of compensation. And, they added, failure to follow the terms of the plan is the most common problem in compensation definitions.
Whether a 501(c)(3) organization offers a 401(k) or a 403(b) has consequences, Diehl and Riordan note. There can be a prejudice in favor of 401(k)s, Deihl indicated, in part due to the misconceptions that employers cannot make contributions to 403(b) plans and that 401(k)s are easier and less expensive to administer. In addition, she said, some advisors only sell 401(k)s.
A key difference between the two kinds of plans is the consequences of late deferrals. For instance, 401(k)s file a Form 5330 and pay an excise tax of 15% for late deferrals, whereas 403(b) plans do not have to follow that procedure if there are late deferrals. “This is a big deal,” Diehl remarked.