It may be counter-intuitive, but reducing the number of employees who are eligible to participate in a retirement plan could be the greater good in certain situations. Maximizing participation may be the goal in most cases, but plan consultants in tune with their clients’ businesses should recognize instances when immediate eligibility and/or automatic enrollment are contraindicated.
For example, industries with very high turnover, such as the restaurant, landscaping, or car wash industries are better served by a one-year waiting period before automatic enrollment takes place. If the plan provides for immediate automatic enrollment or a very short waiting period, transient employees are more likely to get insignificant automatic cash-out distributions that are subject to fees, taxes, and early distribution penalties. Employers with high turnover who are at the cusp of becoming a large plan that will require a financial statement audit are also best served by a longer eligibility waiting period.
Similarly, there can be circumstances in which allowing employees who work less than 1,000 hours per year to participate causes the previously small plan to exceed 120 participants, requiring a financial statement audit to be attached to the Form 5500. To determine if a plan audit is needed, employers must count all eligible employees, regardless of whether they have chosen to contribute deferrals, plus terminated participants who still have an account balance in the plan. Please refer to our previous blog “I don’t want to grow up, I want to be a small plan” for more detail on counting participants for audit purposes. An audit could be a significant enough cost to a plan with high eligibility but low participation to negatively affect active participants if the employer chooses to reduce the discretionary match or profit sharing contribution by the cost of the audit to keep retirement plan expenses within budget.
As practitioners, we are used to finding ways for employers to increase participation, especially when it helps them pass discrimination testing, but sometimes, thinking out of the box requires finding ways to eliminate employees who are not participating. When the majority of eligible part-time or transient employees are not contributing to a retirement plan, and they are the reason why the employer will soon have to incur the cost of a financial statement audit, the employer can consider amending the plan to make eligibility harder. In many cases, employees who have never met the new, tougher requirements would be bumped out of the plan, reducing the participant count if they did not already have an account balance.
Note that amending the plan to make some participants ineligible will not accomplish that goal of avoiding a plan audit if previously eligible participants had received profit sharing contributions, or contributed deferrals and have an account balance. As discussed in our previous submission, Counting participants is not as easy as 1, 2, 3!!!, for purposes of determining whether a plan is necessary, all eligible participants will count as participants, regardless of whether they are participating. Additionally, all terminated or newly ineligible participants who have account balances will also count as participants.
When considering plan amendments to achieve specific business goals, plan sponsors should consult with service providers that understand both plan design and the employer’s goals. In certain cases, premises that we have come to accept as a universal truth, such as maximizing coverage and eligibility to achieve optimal retirement readiness, may actually impair an employer’s ability to make an employer contribution to the participants. Reducing eligibility to a retirement plan to avoid the cost of a financial statement audit might better benefit employees’ retirement readiness.
Sometimes, less is more.
If you have questions or seek additional information on this subject, please contact our Employee Benefit Plan Team.
Maria T. Hurd, CPA
Retirement Plan Audit Services
Chris J. Ciminera, CPA, QKA
Manager – Accounting & Auditing