401(k) FAQs: The Big List for 2021

As we’re now officially in 2021, you may have questions about your 401(k) plan sponsor obligations for the new year. Your employees, as well, may need 401(k) guidance — especially those reeling from the COVID-19 pandemic.

In this Q&A, we address the responsibilities, options, and uncertainties surrounding 401(k) plans in 2021. These include:

• 401(k) contribution limits
• Traditional 401(k)
• Roth 401(k)
• Safe harbor 401(k)
• SIMPLE 401(k)
• Nondiscrimination testing
• Form 5500 reporting
• The SECURE Act
• Pandemic-related guidance

What are the 401(k) contribution limits for 2021?

The chart below represents traditional, Roth, and safe harbor 401(k) plans.

SIMPLE 401(k) plan contribution limits for 2021 (unchanged from 2020):

• Employee contributions = $13,500
• Catchup contributions (employees age 50 and over) = $3,000
• Employer contributions = Up to 3% match, or 2% nonelective contribution

What is a traditional 401(k) plan?

A traditional 401(k) plan lets eligible employees make pretax 401(k) contributions, which means their contributions are subtracted from their gross wages before income taxes come out.

A traditional 401(k) plan lets eligible employees make pretax 401(k) contributions, which means their contributions are subtracted from their gross wages before income taxes come out. This process lowers their taxable wages and increases their net pay. The employee must, however, pay income taxes on their 401(k) withdrawals. As the plan sponsor/employer, you can choose to make matching contributions to your employees’ traditional 401(k) accounts.

The employee’s contributions are immediately vested, meaning the funds fully belong to the employee when the contribution is made. However, the employer matching contribution can be either immediately vested or subject to a vesting schedule. With a vesting schedule, the employee must work for the company for a specific period of time in order to 100% own the matching contribution.

If you have a traditional 401(k) plan, you must perform annual nondiscrimination testing to ensure the plan does not disproportionately favor highly compensated employees (HCEs) and key employees.

What is a Roth 401(k) plan?

A Roth 401(k) plan lets eligible employees make post-tax 401(k) contributions, which means you subtract the contributions after withholding taxes from the employee’s gross wages. This process does not lower the employee’s taxable wages nor does it increase their net pay. On the upside, the employee will not owe taxes on their 401(k) withdrawals.

You can make matching contributions to your employees’ Roth 401(k) accounts. Further, Roth 401(k) plans are subject to the same vesting rules as traditional 401(k) plans, plus annual nondiscrimination testing.

What is a safe harbor 401(k) plan?

Safe harbor 401(k) plans are popular with small businesses because they do not require nondiscrimination testing — which can be an administrative hassle.

A safe harbor 401(k) plan is similar to a traditional 401(k) plan. However, unlike traditional 401(k) plans, the employer’s matching contributions to a safe harbor plan are immediately vested. This means the employee owns 100% of the match right away. There’s no vesting schedule option. Also, safe harbor 401(k) plans do not have to undergo nondiscrimination testing.

Safe harbor 401(k) plans are popular with small businesses because they do not require nondiscrimination testing — which can be an administrative hassle.

What is a SIMPLE 401(k) plan?

The SIMPLE 401(k) plan is designed specifically for small businesses with 100 or fewer employees.

Similar to a traditional 401(k), employee contributions to a SIMPLE 401(k) are pretax. But unlike the traditional 401(k), employers must make either matching or nonelective contributions to employees’ SIMPLE 401(k) accounts. In other words, the employer contribution is mandatory.

Like the safe harbor 401(k), all contributions to a SIMPLE 401(k) are immediately vested. Moreover, SIMPLE 401(k) plans are not subject to annual nondiscrimination testing.

What does non-discrimination testing consist of?

As mentioned, both traditional and Roth 401(k) plans must undergo annual nondiscrimination testing to ensure the plans do not discriminate in favor of highly compensated employees. This is done by conducting (on a yearly basis):

• The Actual Deferral Percentage (ADP) test, which compares HCE pretax contributions to non-HCE pretax contributions.
• The Annual Contribution Percentage (ACP) test, which verifies the employer’s matching contributions.
• Top-heavy testing, which compares owner/officer contributions (also called “key employees”) to non-key employees’ contributions.

What is the Form 5500 filing deadline for 2021?

IRS Form 5500 filing enables you to comply with the Employee Retirement Income Security Act’s annual reporting requirements.

If your 401(k) plan has at least 100 participants, you must file Form 5500 with the U.S. Department of Labor. Plans with fewer than 100 participants can use Form 5500-SF (short form).

Form 5500/5500-SF is typically due by the last day of the 7th month following the end of the plan year. For calendar-year plans, the deadline is July 31.

The SECURE Act: What are some key provisions for 2021?

The Setting Every Community Up for Retirement Enhancement (SECURE) Act — which took effect January 1, 2020 — expands retirement-plan access for small businesses and their employees. Among the SECURE Act’s most pivotal provisions are “pooled employer plans” (PEPs), which began on January 1, 2021.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act — which took effect January 1, 2020 — expands retirement-plan access for small businesses and their employees. Among the SECURE Act’s most pivotal provisions are “pooled employer plans” (PEPs).

For expert insight, we spoke with Norman S. Leslie, financial advisor and financial services executive at Barnum Financial Group.

Leslie explained that PEPs are a new type of Multiple Employer Plan (MEP) that lets small, unrelated employers band together to create a single retirement plan. Ordinarily, to be able to establish a MEP, employers must have a shared commonality, such as the same industry or geographic location. By not requiring a shared commonality, PEPs simplify and expand small business access to 401(k) plans.

“PEPs and MEPs can potentially reduce 401(k) costs and legal liability for small businesses,” Leslie said. “By combining their purchasing power, plan members may lower their 401(k) administration fees plus gain access to pooled investments and higher quality services.”

Leslie reminded that the SECURE Act offers other incentives to small businesses, such as:

• Increased tax credit for adopting a new 401(k) plan
• New tax credit for adding an auto enrollment feature to an existing 401(k) plan

COVID-19: Should plan sponsors and participants hold the line?

Plan sponsors/employers

The economic fallout from the COVID-19 crisis may have you wondering whether to pause your 401(k) matches in 2021, or keep them to retain employees.

According to Leslie, employers should do their best to maintain their 401(k) matches, for these reasons:

• Studies show most Americans do not have enough retirement savings
• For many people, money is the number 1 cause of stress
• Financial problems can distract employees from their work, decreasing productivity
• Potential recruits are increasingly becoming as concerned with income as they are with benefits offered by an employer

“The 401(k) match should be one of the last cutting items on the agenda and should only be suspended or terminated if absolutely necessary.”

Leslie agreed that it’s natural for struggling businesses to seek cost-cutting measures. But given the above reasons, he said “the 401(k) match should be one of the last cutting items on the agenda and should only be suspended or terminated if absolutely necessary.”

Participants/employees

During the pandemic, employees may have misgivings about their 401(k). For example, what if their employer cut their wages? Should they pause their 401(k) contributions? Or, what if their employer laid them off? Should they tap into their 401(k) savings?

Per Leslie, employees should not automatically pause their 401(k) contributions if their wages are cut. He suggested first taking an objective look at your budget. If you do not have a clear grasp of your monthly expenses, the reduction in wages is a great time to employ the use of a budget.

“I recommend creating a budget that identifies (and separates) your needs from your wants,” he said. “This budgetary process will let you know whether there’s room to maintain your 401(k) contributions. By doing an accurate assessment of your needs and wants, you may spot excesses in your spending … excesses that could go toward your 401(k).”

He continued, “Tapping into your 401(k) savings is generally not a good idea, but if you’re laid off and have no alternative, then such an action is understandable.”

Leslie said that employees should remember that, in 2021, premature 401(k) withdrawals are subject to the 10% early withdrawal penalty plus any taxes owed on the distribution. Although the CARES Act temporarily waived the 10% penalty on COVID-19-related early distributions, the provision expired on December 31, 2020.

He concluded by driving home the importance of a budget. “A budget is a saver’s best friend. It should be treated as a very close ally when your income is limited. If you lose your job, your budget can prevent you from burning through your savings or tapping into money earmarked for other purposes — such as retirement or your children’s college education.”