Cash or deferred
retirement plans, more commonly referred to as 401(k) plans, have
become the backbone of the private pension system in America. They
long ago replaced employer-sponsored pension plans as the most common
vehicle for retirement savings.
These plans, which are primarily funded by employee contributions,
typically give employees more control, allowing them to direct their
own investments and providing more access to their money in times of
financial need. But workers can also choose whether or not they want
to participate at all. According to the Department of Labor,
approximately one-third of eligible employees do not participate in
their company's 401(k) plan.
There are numerous reasons why expanding participation is
desirable. Let's look at some of those reasons and discuss ways of
increasing 401(k) participation and retirement savings.
Advantages of Increased Participation
Many workers have seen a significant decline in the value of their
401(k) accounts in recent years not only from investment losses but
also from hardship distributions they took in order to pay their
mortgage, medical bills or college tuition. That's why now, more than
ever, it's essential that employees rebuild these accounts so they'll
have enough to live on when they retire and have funds available in
case of emergency. For many, a 401(k) account will be the only source
of income they have to supplement social security benefits.
An elderly population without sufficient sources of income would
create an economic burden on society, increasing the need for
taxpayer-funded financial assistance. Retirement savings, therefore,
is beneficial to society as a whole, and to the strength and soundness
of our economy.
Here are some other benefits associated with enhanced 401(k)
Studies have shown that retirement plan participation and
satisfaction helps to retain valued employees and keep them happy.
That translates into reduced costs to employers for employee
replacement and helps keep the business running smoothly. Plan
features can have an impact on overall satisfaction with the plan,
as discussed below.
401(k) plans must pass an annual nondiscrimination test, unless
the employer provides minimum contributions as in a safe harbor
401(k) plan. The test ensures that highly compensated employees (HCEs)
are not participating in the plan to a far greater extent than non-HCEs.
HCEs are employees who own more than 5% of the company or who earned
over $110,000 in the prior plan year (increasing to $115,000 as of
2012). In most cases, the more the non-HCEs contribute to the plan
the more the HCEs are allowed to contribute under the test.
Consequently, encouraging participation by lower-paid employees may
directly benefit the HCEs each year.
Certain fees associated with operating a plan may be reduced as
a result of increased participation. Higher asset levels could make
a plan eligible for lower investment fees. And, additional
participants may help spread out administrative costs where they are
paid from plan assets.
In many ways, increasing the level of employee participation is a
win-win situation for everyone.
Methods for Increasing Participation
A number of factors can influence an employee's decision of how
much, if anything, to contribute to the plan. Each employer should
determine which of the following factors are most relevant for its
Relaxed Eligibility Requirements
A 401(k) plan can require up to one year of service and attainment
of age 21 before entering the plan. Participation can be further
delayed by periodic entry dates (quarterly, semi-annually, etc.).
These restrictions tend to discourage participation since a new
employee is more likely to be enthusiastic about the plan when first
hired than after a year or more of not being involved. It's also
easier to explain the plan to new employees when you first have their
attention. The longer the wait to enter the plan the more time there
is for interest to be lost.
Relaxed eligibility provisions should have no negative impact on
401(k) contribution nondiscrimination testing since early entrants can
be eliminated from the test. The age and/or service requirements can
be reduced or eliminated altogether and entry dates can be more
frequent, such as monthly or immediate.
Studies have shown that participation rates can increase by as much
as 34% by adding automatic enrollment provisions to a 401(k) plan.
Under these provisions employees are automatically enrolled in the
plan when they become eligible unless they elect not to participate.
The plan establishes a default contribution rate, which can remain
constant or increase in future years. An increasing contribution rate
is another way to maximize retirement savings. Workers who are
automatically enrolled have 90 days to cancel the arrangement and have
their contributions refunded without penalty.
A Qualified Automatic Contribution Arrangement is an automatic
enrollment provision with certain employee and employer contribution
requirements, which exempts the plan from the annual nondiscrimination
testing (similar to a safe harbor 401(k) plan). The employee deferral
rate must be at least 3% of compensation to start, and increase to at
least 6% by the fifth year of participation, not to exceed 10% of
compensation. Employees always have the ability to change the rate by
making an affirmative election.
The employer must make either a 3% nonelective contribution for
each eligible employee or a matching contribution equal to 100% of the
first 1% of compensation deferred plus 50% of the next 5% deferred for
a maximum matching contribution of 3.5% of compensation. This required
employer contribution must be fully vested after no more than two
years of service.
Automatically enrolled employees who do not complete an investment
election form will have their money put into a default investment.
Plan fiduciaries can limit their liability if the default investment
meets certain rules which would classify it as a Qualified Default
Investment Alternative. The rules are designed to provide long-term
growth while minimizing the risk of large losses.
Annual notices are required for Qualified Automatic Contribution
Arrangements and Qualified Default Investment Alternatives providing
information about the arrangement and the default investment, and
explaining an employee's right to make changes through an affirmation
election or elect not to participate at all.
An Eligible Automatic Contribution Arrangement is another form of
automatic enrollment which does not require employer contributions but
does require an annual notice. Although it does not exempt the plan
from nondiscrimination testing, it extends the correction period for a
failed test from 2½ months to 6 months after the end of the plan year.
Many participants base their salary deferral decision on the extent
to which their contributions will be matched by the employer. The
absence of a match will discourage participation. The formula can be
limited to a maximum deferral percentage, and a common formula is 50%
of deferrals up to 6% of compensation. Matching 100% up to 3% of
compensation results in the same maximum outlay to the employer but
will be less effective at increasing employee deferral rates because
fewer employees will defer above the 3% matched rate. Each employer
must consider what match formula will best serve the needs of the
Regular Employee Communications
Providing employees with information about the plan should not be a
one-time event done only when they are hired. Follow-up communications
can have a big impact on plan enrollment rates as they help remind
employees of the importance of retirement savings as well as the
specific features of the plan. This can be accomplished through
periodic enrollment meetings, frequent distribution of enrollment
forms and materials (including projected benefit illustrations) and
newsletters about the plan. It's a good idea to utilize electronic
media as well as paper documents, and materials should be designed to
be easily understood.
Enhanced Withdrawal Opportunities
Employees will be more comfortable contributing to a plan that
gives them access to their money in times of financial need. Hardship
distributions and loan provisions can provide this comfort. Hardship
distribution rules for deferral accounts have been expanded in recent
years and plan sponsors should determine if their plans have been
updated to include them. In-service withdrawals of other accounts
(e.g., match, profit sharing) could also be considered.
Frequent Election Periods
Each plan establishes the intervals at which participants can make
changes to their deferral elections. Allowing them to discontinue or
reduce their election frequently will make them less afraid to commit
to a higher amount. Some plans offer changes on a monthly basis while
others allow them with each paycheck, and most plans allow complete
discontinuance at any time. Employers should make sure that the
availability to change elections is not too frequent as to create an
administrative burden for the company.
Adequate Investment Options
Having a broad range of investment funds from which to choose and
the opportunity to make frequent exchanges helps to create enthusiasm
for the plan. Funds should be monitored to make sure they remain
competitive and relevant to current investment strategies.
Increasing employee participation in 401(k) plans should be an
ongoing project for all plan sponsors. There are many benefits of
doing so for the company and society. Employees are usually more
content and committed to their jobs when they participate and are
satisfied with the plan. Plan sponsors can do a number of things to
encourage participation, from increasing the company match to having
more flexible plan features. Employers should review their 401(k) plan
provisions and policies to ensure they encourage maximum utilization
of the plan by employees.
IRS and Social Security Annual Limits
Each year the U. S. government adjusts the limits for qualified
plans and social security to reflect cost of living adjustments and
changes in the law. Many of these limits are based on the "plan year."
The elective deferral and catch-up limits are always based on the
calendar year. Here are the 2012 limits as well as prior year limits
for comparative purposes:
Maximum compensation limit
Defined contribution plan maximum contribution
Defined benefit plan maximum benefit
401(k), 403(b) and 457 plan maximum elective
SIMPLE plan maximum elective deferrals
IRA maximum contributions
Highly compensated employee threshold
Key employee (officer) threshold
Social security taxable wage base
This newsletter is intended to provide general
information on matters of interest in the area of qualified retirement
plans and is distributed with the understanding that the publisher and
distributor are not rendering legal, tax or other professional advice.
Readers should not act or rely on any information in this newsletter
without first seeking the advice of an independent tax advisor such as
an attorney or CPA.