Today’s competitive hiring environment is increasing the difficulty for small to medium size non-profits to attract and keep their employees. In hopes of helping with this issue, I want to highlight a way for employers to enhance retirement benefits without adding undo cost and on-going maintenance to the employer benefits offering. This solution is simple to maintain, flexible to employer needs and a cost-effective solution where the deposits go directly to the employee’s account, tax deferred. In fact, it’s quite like the retirement savings arrangements with which you are already familiar. Let’s explore together!
Why don’t we start with the last thought from above; yu may already be familiar with this type of arrangement. Let me ask you a question: What is present in many K-12 education or larger hospital or non-profit employer retirement plans? There is probably a pension and an optional non-ERISA 403(b) elective deferral savings plan. Two separate coordinated retirement plans and accounts that occur side by side for each employee. The employer deposits to the pension on behalf of and in most cases, with the employee. And the employee chooses to save extra toward retirement through the employer-sponsored, payroll deduction 403(b) plan. In this article, I refer to this benefit as a retail 403(b).
Let’s Look at Non-Profit 501(c)(3) Employers
Why don’t these employers simply contribute to the employee’s 403(b) retirement account if they determine that they want to add a benefit like this? Well, they can—but not to the retail 403(b) as described above. If an employer wants to contribute to a 403(b), the governing plan and the account would have to be established under the ERISA guidelines, which comes with annual reporting, funding regulations, possible nondiscrimination testing depending on the type of employer contribution and external costs that may make it prohibitively expensive for a small organization. Let’s discuss the difference between a retail 403(b) (non-ERISA) and an ERISA covered 403(b) employer plan.
A retail 403(b) plan is simply an employer plan in which the employer provides payroll deduction to a retirement account and does not make employer contributions to the employee’s retirement account. It is a very simple plan to administer. It is established by installing a current and compliant IRS pre-approved plan document. A plan document sets the rules of engagement, type of plan benefits to the employees, the parameters of access, employee participation and eligibility for activities such as loans, and is required to list the vendors/options for investing in the 403(b) employer plan. Since the establishment of the IRS pre-approved 403(b) plan program, and to provide reliance to their clients, it has been estimated that 90% of all employers have adopted an IRS pre-approved plan document for their 403(b) plans.
Under this arrangement, employees simply establish an account—at their discretion—with one of the vendors under the plan. The employee decides how their money should be invested within the options of the selected vendor. Finally, the employee completes a salary reduction agreement to indicate how much of their salary will be deferred into this retirement savings account by payroll deduction. The allowed annual maximum amount is determined by the IRS each year. The vendor and/or the TPA monitors that all contributions made are valid and follow IRS guidelines. The employer needs to provide a “meaningful notice” to all eligible employees and must maintain distance; having no role in how the, money is invested in the individual accounts, cannot approve transactions or be involved with the administration of the plan. Either the vendor or a TPA, that acts merely as an aggregator will assist in the administration of the plan.
An ERISA 403(b) plan is an employer plan where typically both the employee and the employer make contributions to the employee’s account. It’s a more complicated arrangement where the money deposited must be separately tracked per the “source” of monies and must be, therefore annually reported to the government for tracking purposes and if there are more than 100 participants in the plan there must be an audit as well. The form used to report this information to the government is the Form 5500.
This form is usually prepared and filed with the government by a TPA or consultant, which provides extra costs to the plan administration. Thankfully, this isn’t the only way an employer can make contributions towards retirement for their employees. There is a middle ground.
The middle ground solution is this: Keep or establish a retail 403(b) plan and set up a SEP-IRA plan alongside it. This pairing provides the ability for employers to contribute to the employee retirement savings without the need to convert to a full-blown ERISA covered plan. The two plans and accounts are separate and coordinated under the same employer, much like what we discussed at the beginning of the article. Here’s how it works.
The Retail 403(b) Employer-Sponsored Plan. This plan is set up according to the guidelines stated above. If established and maintained correctly, it will continue. I should take a quick moment to encourage plan sponsors to perform a plan document review if you have not done so recently. Advisors, please check with employer groups to make sure their documents are up to date and compliant with the latest restatement requirements (deadline was June 30, 2020). Some vendors/advisors/TPAs have a questionnaire for employer plan sponsors to complete. This helps employers to engage this process routinely and stay compliant with the ever-changing laws governing employer plans.
The SEP IRA Plan. SEP stands for simplified employee pension and is allowable for sole proprietors, corporations, and partnerships, including nonprofit organizations. Establishing the SEP-IRA plan is done by the employer by completing a prototype SEP plan. Do not let your employer adopt the IRS model SEP-IRA (Form 5305-SEP); the IRS model form cannot be used by employers that maintain another plan (in this case, the retail 403(b)). It may also be necessary for the board of directors to adopt a resolution to adopt the plan in the organization’s operating documents.
Once established, the employer encourages the eligible employees to open an account within the plan parameters and the employer will make an employer contribution for every eligible employee who earns a minimum of $650 (undated annually by IRS) in the year. In this type of plan, the employer can set up an eligibility period of up to “three out of the immediately preceding five years.” In this case, “work” means one hour not the typical 1,000 hours (or 20 hours per week that is used under the 403(b) plan). The employer can opt in or out of contributions from year to year.
But once the determination is made, it must be executed the same for all eligible employees for a given year. For instance, if an employer is going to make a contribution, they determine the amount and deposit in all eligible employee accounts. It also follows that if an employer determines that no contributions for the year will be made, then no contributions are made on behalf of any eligible employees.
Example 1: An employer determines to make a SEP contribution for 2021. It is decided that 2% of employee’s salary will be contributed. Result: Every eligible employee receives 2% or their annual salary deposited into their SEP account.
Example 2: An employer determines to make a SEP contribution for 2021. It is decided that $200 is to be deposited to each employee’s SEP account. Result: $200 is deposited into each SEP account.
Example 3: An employer determines that $10,000 is to be divided equally to all eligible employees. Result: Each employee receives an equal deposit (a portion of the $10,000) into their SEP account.
Considerations
There are a few things that need to be understood by the employer before they adopt this type of contribution to their SEP plan:
- If the employee owns the account, it is established in the name of the employee under the SEP-IRA plan. The funding vehicle for a SEP-IRA is a traditional IRA. Each employee would execute an IRA agreement, and it is that IRA into which the employer funds the SEP-IRA contribution.
- Eligibility can be a maximum of “working” three out of the prior five calendar years. This is sometimes very confusing for an employer. For example, if an employee “works” during three of the years 2017-2021, then she would be eligible for 2022, assuming she still works for the employer in 2022. However, let’s say the employer wishes to establish the SEP-IRA for 2022 and establishes the plan in June 2023. “All eligible employees” can mean employees who are no longer in your employment when the plan is established. We encourage employers to walk through a few scenarios to make sure they don’t forget this rule.
So pairing the SEP-IRA and the retail 403(b) by an employer can give the small- to medium-sized non-profit employer a great benefit for their employees. Employees need to have all the support they can get regarding benefits, and retirement savings will go a long way in closing the confidence gap for retiring Americans. This idea is not new, but it may be overlooked. To keep it fresh in our minds, we connected our understanding about this solution with one that we already know. Please consider this idea the next time you are asked about what more could be done to enhance employee benefits.
Note: Other considerations are also important—please refer to the IRS website for a complete list. And be on the lookout for another NTSA Net post: “Differences between the IRS Model SEP (Form 5305-SEP) and a Prototype SEP.”
Toni E. Whaley is CEO & co-founder, Paladin Advisor Group, a PlanMember Financial Center.
- Log in to post comments