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INCLUDING FEATURES TO GET THE DESIRED BENEFITS
In a constantly evolving retirement savings landscape, it is a challenge for plan sponsors to remain current with the options available in their 401(k) plan. We feel sponsors can better utilize their time by running their company and outsourcing this advice to a professional who specializes in 401(k) plans. Townsend Financial Life Management spends the time to consult with sponsors and evaluate the company and participants to help design a plan which will provide the desired benefit to the employees and sponsor. Here are some of the design considerations Townsend Financial Life Management will review with you to decide which features best fit the needs of your employees:
Auto Enroll has become a much more common feature in 401(k) plans today. With Auto Enroll, participants that become eligible to contribute are automatically enrolled into the plan at a predetermined deferral rate. Participants have the option to change their deferral rate, including choosing to not contribute at all. Many participants are inclined to not take action when it comes to saving for retirement. By including an auto enroll feature, the participant does not have to take action to start contributing, but has to make the decision and take action to not participate. In most cases, participants want to contribute and find this feature an easy way to get started.
Auto Escalate is very similar to the Auto Enroll, in that it will automatically set participants to a predetermined deferral rate. The difference between Auto Escalate and Auto Enroll is the auto escalate is for participants already enrolled in the plan, who are deferring less than the predetermined deferral rate. Typically this feature is set up to increase participants to the predetermined deferral rate on an annual basis. This feature is very good at letting participants know they should be saving more. Like the auto enroll, participants can choose to opt out, but they are forced to make the decision and take action. This feature is a great tool to encourage all participants to take advantage of their plan.
Auto Increase is a great tool to encourage participants to save more. Most participants are not saving enough to be prepared to retire on time. Auto increase is a feature that increased participants’ deferral rate by a predetermined percentage (typically 1% or 2%) on an annual basis up to a set limit. Like the other automatic plan features, participants can choose to opt out and set another deferral rate, however, they must make that decision and take action. Most participants do not notice a small increase in their deferral but it can make a huge impact at retirement.
Roth 401(k) Option
The Roth Option for a 401(k) plan is a relatively new feature. Making Roth 401(k) contributions allows participants to contribute after tax dollars to their retirement plan. These contributions do not offer the upfront tax benefit that the traditional contribution has, however, like they do offer the tax free growth of a traditional contribution matched with tax free withdrawals in retirement. Many younger participants like to use this feature because of the uncertainty in future tax law out 30 or 40 year when they retire. Another added benefit on the Roth option is that funds can be withdrawn early without the 10% penalty associated with early withdrawals from a Traditional account.
Self-directed Brokerage Window
A well designed 401(k) plan has options in all of the major asset class including options with growth and value strategies. While these funds are typically enough to put together a well-diversified portfolio, some more sophisticated investors may want the option to invest in other funds including individual securities or exchange traded funds. The brokerage window option gives each participant the option to set up a brokerage account within their 401(k) plan to invest in these other options (typically an additional fee applies).
One way to encourage employees to participate in their 401(k) plan is to match their contribution. This means that if employees want to receive this additional benefit they must first help themselves prepare for retirement. There are a number of matching formulas that a sponsor can choose with the help of an advisor to stretch the benefit to the employees and encourage them to contribute more to their retirement account. Many participants also contribute up to the maximum an employer is willing to match to, so a properly set matching formula can encourage participants to contribute at a higher level to better help themselves prepare for retirement.
Profit sharing is a great way to show your employees appreciation and is a great employee retention tool. Profit sharing formulas can also allow the highly compensated employees to increase their contribution above the individual contribution limit. The amount the highly compensated employees are able to contribute depends on the demographics and salaries of the employees. This can be determined using several different testing formulas.
Recruiting and training new employees can be very costly, so retaining key employees is extremely important for a company. One way to keep good employees around is to set a vesting schedule for the employer’s contribution (whether matching or profit sharing) into an employee’s 401(k). A vesting schedule will show the balance of the employer contribution in the employee’s 401(k) balance, however, if the employee leaves the company before the end of the vesting schedule, the employer’s contribution is forfeited and returned to the employer. There are several different types of vesting schedules: graduated or cliff. A graduated vesting schedule gives the employee a set percentage of the employer contribution every year until they are fully vested. A cliff vesting schedule requires the employee to be with the company for a set period of time (the cliff) before the whole employer contribution is vested.
Life happens. While it is not encouraged to take a loan out against your retirement account, it is comforting to some individuals to know in the case of an emergency they can borrow money against their current balance. The ability to take a loan is one of the benefits of a workplace place retirement plan versus an individual retirement plan. Loans have to be repaid and typically have an interest rate that is also deposited into your account.
Hardship withdrawals are special circumstances designated by the IRS that allow a participant to take money out of their qualified account without a penalty to meet immediate and heavy financial needs. Employees that need to take a hardship withdrawal have to have no other funds available to cover the expense. This is a common feature included in a plan to allow employees in desperate need to cover their expenses.
According to the Bureau of Labor Statistics, the average worker will hold 10 jobs before the age of forty. With employees moving jobs so many times, rollovers allow employees to consolidate their previous 401(k) balance into their new plan. This consolidation makes it easier for the participant to manage their account. Typically the non-highly compensated employees (non-HCE) are the ones moving jobs more often. By allowing the non-HCE to consolidate their account into their new plan, it helps the plan to avoid being top heavy.
Eligibility can be thought of in two different aspects: age and length of employment. Most plans are eligible to employees over 18 years old. The length of employment eligibility helps to avoid the administrative burden of short term employees from entering and exiting the plan constantly. Also if there is a matching or profit sharing, it incentivizes employees to stay with that company to be able to receive those additional benefits.
Safe Harbor Plan
A top heavy plan means that the highly compensated employees have over 60% of the assets in the plan. Testing is done on an annual basis to test for this to make sure the plan is not unfairly favoring the highly compensated. If your 401(k) plan has become top heavy it is very difficult to reverse that trend. To avoid penalties for being top-heavy, a sponsor can elect to make a plan a Safe Harbor plan. In a Safe Harbor plan, the sponsor elects upfront to make a matching or profit sharing contribution of the specific amount required, along with other plan feature requirements, and in return the plan is exempt from the top heavy testing requirement.
A bundled 401(k) plan means the record keeper acts as the administrator also and completes the tasks that can be completed by a third party administrator (TPA). There are both advantages and disadvantages to using a TPA with your 401(k) plan. TPAs are hired by the plan sponsor to run the day to day activities of the 401(k) plan. These activities include required paperwork, contributions, loan initiation, testing, and preparing other plan documents. In a bundled plan these duties would be handled by the plan provider.