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
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 particular situation.
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 company.
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
|Defined benefit plan maximum benefit
|401(k), 403(b) and 457 plan maximum elective deferrals
| Catch-up contributions
|SIMPLE plan maximum elective deferrals
| Catch-up contributions
|IRA maximum contributions
| Catch-up contributions
| Highly compensated employee threshold
|Key employee (officer) threshold
|Social security taxable wage base
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