Which employers will use a starter 401(k) deferral-only arrangement?

Beginning with 2024, new Internal Revenue Code § 401(k)(16) sets up a new kind of individual-account retirement plan—a starter 401(k) deferral-only arrangement.

For relief from top-heavy treatment and from actual-deferral-percentage nondiscrimination constraints, the price is providing no contribution beyond elective deferrals, and limiting them to $6,000 (or $7,000 for those 50 and older).

Under which conditions would an employer prefer a starter 401(k) over sending payroll deductions to Individual Retirement Accounts?

Is it about saying, in recruiting workers, that the employer has a “401(k) plan”?

Under which circumstances would it be rational for an employer to pay (instead of letting participants bear) all or some of a starter 401(k)’s plan-administration expenses?

Hi Peter - off the top of my head (with no other active thought about the subject) I'd say that the thrust of this provision was mostly to keep employers from being forced into the state-run systems which are being implemented by an increasing number of states. I have a hard time seeing other useful purposes, although there likely are some that I haven't considered. Like you, I'll be interested to see what people come up with for situations where it might be the preferred option.

The Starter 401(k) very likely is going to be the darling of fintech.  The narrow focus of the design will allow them to create a simplified administrative structure from document signing through recordkeeping, investment, and ultimately distributions with very low overhead.  Existing recordkeeping systems are designed to be all things to all plans and have an enormous amount of overhead to anticipate the myriad of ways plans can go off the rails.  Take things like employer contributions, allocations, vesting and forfeitures off the table and the technology infrastructure shrinks dramatically.

Expect the cost of set up and recurring services to be exceptionally low, and any tax benefits to the employer for starting and operating a plan are an added selling point. 

The biggest difference with using IRAs for an employer is the Starter 401(k) will have a single payroll feed to a single provider, and will plan level reporting available.

Starter 401(k)'s will be available nationwide versus state plans.  Starter 401(k)'s will have a much broader market available to them over state plans.  Keep in mind that almost half of all businesses (and almost of of them are small businesses) do not have a retirement plan. 

There's more, and there were advocates who are prepared to implement Starter 401(k)'s that lobbied Congress to make them available.

Thanks, Belgarath and Paul I.

401(k)(16) allows a no-cost plan with no nonelective or matching contribution as a way to not suffer a tax or other consequence under a State’s play-or-pay law.

In finding reasons for a business owner to choose an employer-maintained plan over an absence of ERISA fiduciary responsibility, getting the employer an opportunity to say it has a “401(k) plan” might matter (perhaps for some employers).

Interesting point about only one payee for all pay deductions for retirement contributions.

Likewise, for an employer otherwise exposed to many subnational laws, using an ERISA-governed plan avoids multiple laws and conflict-of-laws issues.

(Had States making play-or-pay laws been smarter, they would have made a compact for all those States to use one IRA provider. And the States’ laws might have included an ordering rule to let one State’s default contribution suffice under all States’ laws.)

Paul I, do you think some service providers for § 401(k)(16) plans will offer to serve as a plan’s administrator so an employer could do nothing in deciding claims for distributions, deciding whether a domestic-relations order is qualified, filing Form 5500 reports, and doing other plan-administration tasks?

I believe that the preferred model will be a PEP which would cover most if not all plan administration tasks. 

Using a pooled-employer plan might further simplify the administration, especially if all participating employers are 401(k)(16) employers and the pooled-plan provider sets which, if any, before-retirement distributions are allowed.

Will small employers' advisors drive their sponsor clients to these pooled arrangements?  Wouldn't they prefer more of a finger in the pie, teaming with a local TPA/advisory firm to something more tailored?

Some pooled-plan providers have designed the plans to allow each participating employer to:

specify its subplan’s investment alternatives;

choose to include or omit some kinds of distributions and other plan features; and

direct the trustee or custodian to pay an adviser’s fee.

And some third-party administrators serve as the pooled-plan provider or its service provider.

A deferral-only § 401(k)(16) arrangement might fit for an employer that needs or want to facilitate pay deductions for retirement contributions, won’t provide a nonelective or matching contribution, and prefers a 401(k) over IRAs for reasons about efficiency or convenience.

Yet, many employers will see value in more carefully designed plans with finer service.

Keep in mind that Starter 401(k) primarily are designed primarily for small companies that do not have plans.  They will not start out with a pot of accumulated assets and likely will not grow quickly.  There are a lot of financial advisers that will shun the plans until the AUM grows.

On the other hand, there is a fair amount of interest among some financial advisers that would like to team up with a fintech company or PEP with view that a lot of plans with small AUM collectively add up, and the FA would have an inside track for spinning off a plan that does outgrow the Starter 401(k) into full fledged 401(k).  Time will tell if this is visionary.

I wanted to make the following points: First, building on what Peter and Paul I were discussing where a PEP is involved and taking it one step further, if a PEO sponsors a PEP, it would have the advantage of offering a one-source payroll and benefits operation at a distinct reduction in overhead to adopting employers. Secondly, I wanted to point out that the starter 401(k) approach seems to be a variation of the SIMPLE 401(k) plan theme but with no employer contribution requirement. Finally, Responding to Paul I's comments about the use of a starter 401(k) as an alternative to participating in a state-run IRA, I think it is a very valid point -- the states that have adopted such laws have been confined to utilizing an IRA-based platform to avoid ERISA preemption issues. Perhaps a SECURE 3.0 might include a provision that a state's mere adoption of a saver's choice type program mandate will not be considered preempted by ERISA if it includes a starter 401(k)-like arrangement.