Tag Archive for: QACA

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A SIMPLE Switch

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“Can I terminate my SIMPLE IRA plan and start a 401(k) plan mid-year?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Minnesota is representative of a common inquiry related to SECURE Act 2.0 of 2022 (SECURE 2.0).

Highlights of the Discussion

That’s a straightforward question that, currently, has a problematic answer due to the “exclusive plan rule,” which says the SIMPLE must be the only plan the business maintains for the year. Problem solved—thanks to SECURE 2.0 for plan years beginning after December 31, 2023.

For the 2024 plan year and later plan years, employers may replace their SIMPLE IRA plans mid-year with what we will call an “eligible 401(k) replacement plan.” The annual deferral limits are different for the two plan types. Therefore, under the new rules, the participant’s annual deferral limit will be prorated (by day) between the SIMPLE IRA plan and the eligible 401(k) replacement plan for the year.

An eligible 401(k) replacement plan, for this purpose, is a

  • SIMPLE 401(k),
  • Safe Harbor 401(k),
  • 401(k) with a qualified automatic contribution arrangement (QACA), or
  • Starter 401(k) (new under SECURE 2.0).

 

Eligible 401(k) Replacement Plan Key Characteristics
A SIMPLE 401(k)
  • Employer has 100 or fewer employees
  • Must be the only plan maintained by the employer
  • Must file a Form 5500 annually
  • Voluntary employee deferrals
  • Mandatory employer contributions (generally, 3% match or 2% nonelective)
  • Immediate vesting for contribution types
  • Additional information at IRS SIMPLE 401k facts
Safe Harbor 401(k)
  • No limit on number of employees
  • Voluntary employee deferrals
  • Mandatory employer contributions—3 options
  1. Basic match: 100% percent match on deferrals up to 3% of compensation and a 50% match on deferrals between 3% and 5%
  2. Enhanced match:  At least equal to the aggregate match under the basic match formula (e.g., 100% match on deferrals of 4% compensation) or
  3. A 3% nonelective contribution
QACA 401(k)
  • No limit on number of employees
  • Automatic enrollment of at least 3% with automatic escalation of at least 1% annually after the initial period, to at least 6% up to a maximum of 15%
  • Mandatory employer contributions—2 options
  1. Matching contribution: 100% match on deferrals up to 1% of compensation and a 50% match on deferrals between 1% to 6% of compensation; or
  2. A 3% nonelective contribution
  • Two-year vesting schedule could apply to employer contributions
  • Standard Form 5500 filing rules apply
  • Additional information IRS QACA facts
Starter 401(k)

Available for plan years after December 31, 2023
  • For employers without a qualified plan
  • Must be the only plan maintained by the employer
  • No limit on the number of employees
  • Automatic enrollment at 3% up to 15% of compensation
  • Deferrals limited to the annual IRA contribution limit (i.e., $6,000 indexed, plus $1,000 in catch-up indexed)
  • No employer contributions
  • Standard Form 5500 filing rules apply

What’s more, SECURE 2.0 will help SIMPLE IRA plan participants who are experiencing a mid-year plan switch, overcome another, potentially expensive, hurdle. Currently, SIMPLE IRA participants cannot roll over the assets from their SIMPLE IRAs to another plan within the first two years of participation without incurring a 25 percent penalty, unless they have a penalty exception (e.g., age 59 ½). During the initial two-year participation period participants can only transfer money to another SIMPLE IRA. SECURE 2.0 will waive that penalty starting with the 2024 plan year in certain circumstances. If an employer terminates a SIMPLE IRA plan and establishes a 401(k) plan (or, for rollover purposes, a 403(b) plan), rollovers between the SIMPLE IRAs to the new 401(k) plan are allowed if the rolled amount is subject to 401(k) distribution restrictions (e.g., age 59 ½, death, severance of employment, hardship, etc.).

Through the 2023 plan year, however, the current SIMPLE IRA rules are in place. Consequently, if an employer maintains another plan during the same year it has a SIMPLE IRA plan, the employer violates the exclusive plan rule and invalidates the SIMPLE IRA plan, technically, making all contributions to the SIMPLE IRA excess contributions. According to the IRS’s, SIMPLE IRA Plan Fix-It Guide, which is based on its Employee Plans Compliance Resolution System (EPCRS), the business owner may be able to file a Voluntary Correction Program (VCP) submission requesting that contributions made for previous years in which more than one plan was maintained remain in the employees’ SIMPLE IRAs. User fees for VCP submissions are generally based upon the current value of all SIMPLE IRAs that are associated with the SIMPLE plan. Self-correction is not available for this type of error. Further correction information is available here.

Options for 2023 when considering a mid-year plan switch from a SIMPLE IRA plan

  • Wait to start a new 401(k) plan until January 1, 2024, providing required notices prior.
  • If a switch to a 401(k) plan is made mid-year 2023, contemplate a VCP filing.

Options for 2024 when considering a mid-year plan switch from a SIMPLE IRA plan

  • Wait to start a new 401(k) plan until January 1, 2025, providing required notices prior.
  • Take advantage of the SECURE 2.0 change and adopt one of the eligible 401(k) replacement plans.

Conclusion

For 2023, switching from a SIMPLE IRA plan to another plan type mid-year is problematic, and may involve an IRS VCP filing (with fees). SECURE 2.0 provides relief for 2024 and later years for this scenario when adopting an eligible 401(k) replacement plan.

 

 

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401(k)s and Davis Bacon “Prevailing Wage” Rules

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“One of my clients has employees who are subject to a prevailing wage determination. The employer has a QACA 401(k) plan. Could the plan sponsor use deferrals and matching QACA contributions to satisfy the fringe benefit portion of the prevailing wage determination?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans, including nonqualified plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from California involved a qualified automatic contribution arrangement (QACA) covering participants doing covered employment under the Davis-Bacon Act (also known as prevailing wage).

Highlights of Discussion
Before answering the question, let us lay a bit of a foundation. The Davis-Bacon and Related Acts and Reorganization Plan No. 14 of 1950 (DBRA) requires contractors and subcontractors to pay laborers and mechanics employed on a covered project jobsite not less than the prevailing wage rates (including fringe benefits) listed in the contract’s Davis-Bacon wage. The purpose of the DBRA is to protect communities and workers from competition from nonlocal contractors who might obtain federal construction contracts in the area by underbidding local wage levels. Prevailing wage amounts for both wages and fringe benefits are determined by the Wage and Hours Division of the Department of Labor, however, the Employee Benefits Security Administration (EBSA) is responsible for regulating the application of the fringe benefits under DBRA.

The prevailing wage determination consists of two components: The basic hourly rate and the basic fringe benefit rate. For the purposes of satisfying the wage determination, employers may pay any combination of the basic hourly rate and the fringe benefit amount, so long as the total amount paid equals the total of the basic hourly rate plus fringe benefit in the determination. In other words, the plan sponsor may pay more in cash, and less in fringe benefits than the determination specifies, or vice versa. For a fringe benefit to satisfy the prevailing wage determination, it must be made to a bona fide prevailing wage plan.

With that background out of the way, let us get back to the original question. Elective deferrals made by an employee covered under the DBRA cannot satisfy the fringe benefit portion of the prevailing age determination, because the employer does not make them. Elective deferrals under the DBRA are considered employee contributions subject to the same taxation, testing and regulatory rules applicable to all 401(k) deferrals. As an aside, all contributions made by employees that are paid by employees for fringe benefits must be voluntary under the prevailing wage rules.

However, a plan sponsor can take credit for employer contributions made to a bona fide fringe benefit plan, and a QACA qualifies as such, but there is a catch. For an employer to take full credit for contributions to a bona fide fringe benefit plan, they must be fully vested, or they become subject to a process called “annualization.” A full explanation of annualization is beyond the scope of this discussion, but annualization basically requires a plan sponsor to spread any unvested contributions made to a fringe benefit plan over all the hours worked by a participant doing covered work under DBRA, as well as work that is not covered under DBRA, and it is very common that employees perform work under both DBRA and nonDBRA assignments. Because the employer must spread unvested contributions it makes related to DBRA covered work, over all hours worked by a participant, this typically serves to dilute the value of the contributions that can be used to satisfy the fringe benefit portion of the prevailing wage determination. With QACA plans, when a match is used to satisfy the safe harbor requirement, the match may be subject to a two-year vesting schedule, so there is a possibility that some DBRA-covered participants receiving the match will have their match annualized. Consequently, most Davis-Bacon plans provide for immediate eligibility and full vesting for contributions in order to avoid annualization [(29 C.F.R. § 5.5(a)(1)].

Conclusion
Although QACA matches can be used to satisfy the fringe benefit determination under work covered by the DBRA, an employer may not get full credit for a matching contribution if it is not fully vested. In addition, not all participants will receive the match if they elect not to defer into the plan, so the employer will have to provide those individuals who did not receive the match with an amount in cash commensurate to what the match recipients received. This would complicate the prevailing wage reporting and cost more, because whenever an amount is paid in cash rather than as a fringe benefit, it is subject to Federal Insurance Contributions Act (FICA) and other employment taxes, and these taxes cannot be used to satisfy the DBRA fringe benefit requirements.

Employers may want to consider satisfying their safe harbor requirements and their DBRA fringe benefit obligations by providing a fully vested nonelective safe harbor contribution rather than a nonvested contribution. This approach would be beneficial for several reasons, including,

1. Satisfying the safe harbor requirement for testing;
2. Avoiding annualization since safe harbor nonelective contributions are fully vested;
3. Simplifying the tracking of DBRA fringe benefits because all participants will get the same fringe benefit to the plan;
4. Cost savings on employment taxes since there would be no cash payments made to participants who did not receive a match; and
5. Using the contribution to satisfy the gateway test pursuant to Treasury Regulation 1.401(a)(4)-8(b)(1) if the plan also uses a new comparability profit sharing formula.

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Applying a QACA Election

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“My client is implementing a QACA in her 401(k) plan. Does she have to apply the default election provision to all participants?”

Highlights of the Discussion

In general, according to IRS rules, your client would not have to apply the QACA default election to any employee who is eligible to participate in the 401(k) plan prior to the effective date of the QACA and has a previous salary deferral election in place or has affirmatively elected not to defer at all [ Treas. Reg. § 1.401(k)-3(j)(1)(iii)].

However, your client should check the terms of the plan document for the precise application of the default election. Sometimes a plan can be designed to apply the default election to those participants whose current deferral percentages are less than the QACA default deferral percentage.

Also, it could be possible for a plan to contain a provision where a participant’s current election expires after a set amount of time. In that case, the plan could then apply the QACA default percentage unless the affected participant executes another affirmative deferral election or opts out.

Conclusion

In a 401(k) plan with a QACA, there are exceptions to applying the QACA default deferral percentage. The best source to turn to is the plan document for the precise application of the QACA default election.

© Copyright 2024 Retirement Learning Center, all rights reserved
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What does it take to be a QACA?

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“Does the IRS have specific requirements that apply to an automatic escalation feature in a qualified automatic contribution arrangement (QACA) 401(k)?

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • Yes, in addition to other requirements for a QACA, the auto-enrollment and escalation features in a QACA must satisfy a minimum and maximum amount related to the percentage of compensation (“default percentage”) that, in the absence of an affirmative election, is automatically deducted from employees’ wages and contributed to the plan as elective contributions [Internal Revenue Code Section (IRC §) 401(k)(13)(C)(iii)].
  • Under Treasury Regulation 1.401(k)-3(j)(2), in general, a default contribution percentage is a qualified percentage only if it is “uniform” for all eligible employees, does not exceed 10%, and satisfies certain minimum percentage requirements. The default percentage must be at least
  • 3% during the “initial period;”
  • 4% during the first plan year following the initial period;
  • 5% during the second plan year following the initial period;
  • 6% during the third and subsequent plan years following the initial period.
  • The initial period is the date an employee is first covered by the QACA through the end of the following plan year. For example, if an employee is eligible under the QACA on 02/01/17, the initial period may run through 12/31/18
  • A uniform percentage, generally, means that the default percentage must be the same for every employee with the same number of years or portions of years since the beginning of the employee’s initial period. The percentage can vary to accommodate certain statutory restrictions, however. For example, the default election is not applied during the period an employee is not permitted to make elective contributions because of a six-month suspension following a hardship withdrawal under Treas. Reg. 1.401(k)-3(c)(6)(v)(B). (Please see Part 4 Examining Process Section 4.72.2.14.3 of the IRS’ Manual for further details and exceptions.)
  • A plan could avoid these automatic increases in the default percentage, often referred to as an “escalator,” by having just one default percentage of between 6 and 10% of compensation.
  • The IRS provides further clarification of QACAs in Revenue Rulings 2009-30.  Plan sponsors must be aware that the auto-enrollment and escalation features in a QACA must satisfy minimum and maximum contribution percentage requirements.

Conclusion

Plan sponsors must be aware that the auto-enrollment and escalation features in a QACA must satisfy minimum and maximum contribution percentage requirements.

 

 

 

 

 

 

 

 

 

 

 

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