According to Merriam-Webster.com, conventional wisdom is defined as "the generally accepted belief, opinion, judgment, or prediction about a particular matter." In other words, kind of the opposite of creative, innovative and cutting-edge. Sometimes, the safety and ubiquity of conventional wisdom may be preferable; however, one must challenge convention to set oneself apart.
What does any of this have to do with being an effective 401(k) adviser? Plenty! There are many aspects of the business that are much less unique than they once were - access to open architecture recordkeeping platforms; availability of professionally managed model portfolios; ability to automatically rebalance on a periodic basis; and capturing of revenue sharing. All of these once set apart those who could deliver them; now they are simply expected.
The rules and regulations that are an inescapable reality of this business impose certain boundaries we cannot cross. However, within those boundaries is quite a bit of room for creative problem solving for the adviser who is willing to bring some unconventional solutions to the table.
Many advisers and service providers assist their clients with plan design. But, what exactly does that mean? Is it suggesting a safe harbor 401(k) to solve a testing problem? These might be viable options, but we must take a step back and ask if there is a better mousetrap and how best to build it. It is also important to balance creativity with simplicity. Proposing a complex solution to a client that has limited resources to manage it may solve one problem, but create another.
That's not to say that creative solutions have to be complicated. Much of the conventional wisdom in the 401(k) market has overcomplicated things.
Analyzing options
One design option to consider is the outright exclusion of certain groups of employees from all or some portion of a plan. A plan can easily carve out highly compensated employees and up to 30% (or sometimes more) of its non-HCEs and still satisfy the applicable nondiscrimination tests. A law firm excluding associates who are mostly, but not completely, HCEs is a prime example. Such exclusions can be effective tools for limiting costs and/or targeting benefits.
There is also the idea that a safe harbor 401(k) is the go-to solution for solving an ADP testing problem. Safe harbor options do solve the problem, but they come at the cost of mandatory contributions and limited flexibility. Other alternatives such as the targeted qualified nonelective contribution can provide lower-cost solutions that also maintain flexibility for the plan sponsor. Even after regulatory changes limited the use of targeted QNECs, they remain a viable alternative to the safe harbor that can produce a cost-effective result.
Consider this example: I Love Rock N Roll, Inc. sponsors a 401(k) plan that covers 12 participants - two HCEs with an average deferral rate of 10% and 10 non-HCEs with an average deferral rate of 4%. The two groups must be within two percentage points of each other in order for the test to pass.
* Safe harbor nonelective contribution: Total contribution cost of $17,850.
* Safe harbor matching contribution: Total contribution cost of $14,650.
* Targeted QNEC: Total contribution cost of $13,800.
Savings of $4,000 might not sound like much to a large employer, but it can be meaningful to a company that has only 10 employees.
How about limiting HCE deferrals to pass a failing ADP test? Yep, that can work also, as described in another example:
Turntables, Inc. sponsors a 401(k) plan for its 2,500 employees, 29 of whom are HCEs. The plan consistently fails the ADP test, requiring close to $50,000 in refunds. The $100,000 QNEC required to pass is not cost-effective. Implementing automatic enrollment at 3% is projected to pass, but it will increase the company's match cost by nearly $200,000.
Alternatively, Turntables could amend its plan to cap HCE deferrals at 2% of pay (plus catch-up contributions for those over the age of 50) and establish a non-qualified deferred compensation plan for the HCEs to allow them to defer up to or in excess of the $17,500 normally permitted in the 401(k) plan.
Uncommon use
Unconventional plan design may also include alternative uses for common designs. One example is using new comparability to make participants whole following the assessment of a surrender charge.
Typically, the surrender charge is assessed based on account balance, while contributions are allocated based on compensation. The different bases make it virtually impossible to target contributions to those impacted by the surrender charge. New comparability designs in which each participant is a separate allocation group can go a long way toward solving this challenge.
The first step to thinking unconventionally is listening. By listening between the lines we can often gain additional insight that allows us to propose solutions that would never even occur to competitors.
Pozek, ERPA, QPA, QPFC, is a partner at DWC ERISA Consultants, LLC and is based just outside of Boston. Reach him through LinkedIn.com/in/AdamPozek or via
