DC Plan Design: A 401(k)/403(b) Guide for Employers

As a plan sponsor, you're faced with numerous decisions about how to structure your retirement plan. How do you design a plan that meets your fiduciary obligations and provides your participants with the best possible opportunities for a secure retirement?

We help plan sponsors navigate and optimize plan design decisions to build plans that prepare participants for retirement readiness, meet fiduciary responsibilities, and achieve organizational objectives.

Key areas we help address:

• Structuring best-practice eligibility requirements
• Determining appropriate use of automatic features
• Making the most of an employer match to drive savings rates
• Setting appropriate policy on loans and withdrawals
• Keeping fees fair for all participants
• Whether to use a bundled provider or an open architecture structure
• Evaluating the pros and cons of using a discretionary ERISA 3(38) fiduciary

There is no such thing as a "one size fits all" 401(k)/403(b) plan. Excellence in DC plan design demands matching plan specifications to employer goals and employee demographics — whether that means maximizing owner contributions at the lowest cost, or incentivizing broad employee participation.

Plan type and plan features are elected at the outset of the design process:

• A 401(k)/profit sharing plan can be sponsored by private or tax-exempt organizations.
• A 403(b) plan can be sponsored by tax-exempt or public education organizations.
• A 457(b) plan can be sponsored by tax-exempt or certain government organizations.

The plan's effective date affects compensation used for the first plan year — a calendar-year plan with a January 1 effective date calculates contributions on full-year compensation, while a mid-year effective date uses pro-rated compensation.

Core plan features to elect include: Pre-tax 401(k), Roth 401(k), Safe Harbor, Match, and Profit Sharing.

Employers may allow new employees to enter the plan immediately, or require a waiting period with minimum age requirements. Entry dates can be limited to monthly, quarterly, or semiannual windows.

Employers with a more transient workforce generally favor more restrictive eligibility requirements. The law permits excluding union employees and nonresident aliens; other classes of employees may be excluded only if they don't exceed 30% of the workforce.

Eligibility is set independently for each contribution type — 401(k)/Safe Harbor, Match, and Profit Sharing — with separate service requirements, age requirements, and enrollment dates for each.

The law permits excluding certain types of compensation without issue, including pay earned prior to plan entry and fringe benefits. Excluding other types of compensation (bonuses, overtime, etc.) subjects the plan's compensation definition to special annual nondiscrimination testing.

Plan compensation generally means wages and other payments reported on Form W-2, with optional exclusions for fringe benefits and post-severance pay (unused sick, vacation, or leave paid within 2½ months of termination).

401(k) deferrals are pre-tax contributions made at an employee's election, in lieu of cash compensation. Roth deferrals work the same way but are contributed on an after-tax basis.

An automatic enrollment feature enrolls employees without an affirmative election, subject to their right to opt out or change their deferral amount — this generally increases plan participation. A Qualified Automatic Contribution Arrangement (QACA) is a special automatic enrollment design that also satisfies safe harbor requirements.

Employers can set a deferral limit as a percentage of compensation, or rely on IRS limits alone. Employees can typically start or change their deferral election per payroll, monthly, quarterly, or semiannually.

A safe harbor 401(k) plan automatically satisfies ADP/ACP nondiscrimination testing, and — when the only contributions are elective deferrals and safe harbor contributions — automatically satisfies top-heavy minimum contribution requirements.

Eligible safe harbor contributions include:

• 4% matching contribution
• 3.5% matching contribution (QACA safe harbor plans only)
• 3% non-elective contribution

These are non-discretionary (required) contributions, must be 100% vested immediately, and cannot carry allocation conditions. Sponsors typically choose between a Basic match formula, an Enhanced formula, or a QACA formula — or a non-elective contribution of at least 3% of included compensation.

A plan may provide a matching contribution tied to participant elective deferrals. The formula can be discretionary — set by the employer each year — or fixed and required.

Key design factors:

• Whether the employer wants discretion in setting the match amount each year
• Whether the formula should be tiered across different deferral levels
• Whether the match should be capped to a percentage of compensation or a dollar amount

If the match is funded after year-end, the plan can require participants to satisfy allocation conditions (e.g., a minimum number of hours worked, or employment on the last day of the plan year) to receive it. Any such restriction subjects all matching contributions to nondiscrimination testing under a safe harbor plan.

A profit-sharing feature gives employers flexibility to determine their annual contribution using a discretionary formula — contributing more in profitable years and less when business slows, without amending the plan.

Three principal allocation formulas:

• Pro Rata — allocates a uniform contribution percentage among participants
• Integrated — provides a greater allocation on compensation above the Social Security taxable wage base
• New Comparability — permits different allocation rates by employee class, subject to nondiscrimination testing

As with matching contributions, allocation conditions (hours worked, last-day employment) can apply if the contribution is funded after year-end, and any restriction requires annual (not per-payroll) funding.

At Normal Retirement Age (NRA), participant accounts become immediately 100% vested. The maximum retirement age allowed by law is the later of age 65 or the 5th anniversary of plan participation. Most plans set NRA at age 65.

401(k) deferrals and most safe harbor contributions must always be 100% immediately vested. Other employer contributions — match and profit sharing — may follow a vesting schedule; a terminating participant is entitled only to their vested balance, and any unvested portion is forfeited back to the plan.

Common vesting schedules:

• 100% immediate vesting
• 3-year cliff (0% in years 1–2, 100% at year 3)
• 6-year graded (20% each year after year 2)

Employers with a more transient workforce often favor lengthier vesting schedules. Forfeitures can be used to pay plan expenses or reduce future employer contributions. Plans may also grant special 100% vesting on death or disability.

Most plans permit a lump-sum distribution upon separation from service, requiring the participant to take their entire vested balance at once. Some plans also offer installment or partial payments.

Plans may permit "in-service" distributions — available at age 59½ or older, or upon a qualifying hardship event as defined by law. Small account balances may be handled through involuntary cash-out: balances under $1,000 may be distributed in cash, and balances under $5,000 may be rolled into an IRA on the participant's behalf.

Employers can choose to allow or disallow participant loans. Loans are popular with employees but add administrative complexity, since the employer or plan administrator must process and track loan requests and repayments.

Common design decisions include the maximum number of loans permitted at one time and whether repayments are deducted directly from payroll alongside plan contributions.