The Internal Revenue Code (IRC) addresses certain aspects of the requirements relating to plan design and plan operations. There are many plan qualification requirements to consider when setting up a 401(k) or other qualified benefit plan. In addition, when setting up a 401(k) plan, the plan sponsor (generally the employer) must consider their internal operations and the needs of the company, the company’s owners and their employees. The following are items to consider when setting up a 401(k) plan:

1. Non-discrimination of Contributions and Benefits – An employee who is a more than 5% owner and/or is highly compensated, based on compensation thresholds established by the IRC, is considered a Highly Compensated Employee (HCE). The plan must not discriminate in favor of HCEs with respect to contributions or benefit offerings. Non-discrimination testing must be performed each year. In addition, there are Safe Harbor Plan options that the company may consider if the company has a significant number of HCEs.
2. Limitations on Contributions – The IRC limits contributions made by employees and employers into the plan. In addition, the IRC limits the base compensation which may be considered when calculating employee deferrals and employer contributions. These limits are indexed for inflation.
3. Minimum Vesting of Employer Contributions – An employee is always 100% vested in their own contributions deferred into the plan. The IRC sets a maximum vesting period for employer contributions. The vesting period cannot exceed 6 years under a graded vesting schedule, or 3 years under a cliff vesting schedule.
4. Minimum Participation Requirements – Employees must generally be allowed to participate in a qualified plan once he or she reaches age 21 and completes 1 year of service. A company may be more lenient on these requirements.
5. Distributions from the Plan are Restricted – Plan assets may not be distributed to a plan participant until such time that a distributable event has occurred. A distributable event is generally defined as severance from employment with the plan sponsor, reaching certain age requirements, death, disability, or financial hardship, as defined by the IRC. The plan may allow a participant to take a loan from his or her account balance, which must be repaid within a certain time frame.

The company should enlist the consultation of a qualified third party administrator when establishing a qualified plan. The third party administrator should use the above factors in conjunction with company specific requirements, such as tax savings for the company, retirement savings for the company’s owners, and utilizing the benefit plan as a way to attract and retain employees. In addition, the third party administrator should be heavily involved in an ongoing basis to ensure the requirements of the IRC are being met in order for the plan to maintain its tax exempt status.

For more information on requirements relating to plan design and plan operations please contact any member of our Employee Benefit Plan Services Team or call 888-KLR-8557.