By Judy Simons and Valerie Gieseke, Tri-Ad
401(k) plan sponsors generally do not relish the annual call from their 401(k) consultant with their plan's nondiscrimination testing results. If your plan regularly passes testing, that's great news. However, if you are not so fortunate or your plan is on the cusp, there are steps you can take to greatly increase your plan's chances of success. This article discusses those choices.
- Assess alternate testing methods. A technically savvy retirement plan consultant may be able to get your plan to pass using a testing method different from the one you have customarily used. If your plan just barely passes with an alternate testing method, you most likely will still want to consider making some changes to ensure a better outcome in following years.
- Make any necessary refunds. Once your plan fails the testing, you must take corrective measures to keep your plan qualified—doing so is not optional. Generally, the first step is to reduce the contributions incurred by the highly compensated participants to the point where the plan will pass the tests. Those highly compensated employees who defer the most in dollar terms receive refunds first. For 2008 plan year and forward, refund distributions are taxable in the year in which they are made.
This, of course, creates communications issues with the higher-paid employees. If the failure appears to have been an aberration, you may be able to treat it as such. If it appears to be part of a trend, you may want to advise affected employees to reduce their deferral percentage to minimize their refund, or to be prepared to receive refunds in future years.
- Consider making a qualified non-elective contribution (QNEC) or qualified matching contribution (QMAC). If cutting back the highly compensated employees' contributions is highly unpalatable, there are other options. A QNEC is an employer contribution that is made to the plan on behalf of every eligible employee, whether or not he or she contributes to the plan. A QMAC is an employer matching contribution that is allocated only to those employees who defer. The employer would need to contribute enough money to make the plan pass the nondiscrimination test. Most employers do not take these approaches because doing so is expensive and because the employer contributions are 100 percent vested immediately.
- Build a case for retirement savings. Many employees do not save for retirement because they truly do not understand how important it is to do so and how dire the future they might face could be if they do not. Placing retirement savings in context is essential but rarely done well. Also, helping employees understand how the little choices they make every day can have huge impacts over time can help the message.
- Target non-highly compensated employees for a participation campaign. The reason a plan fails testing is that non-highly-compensated employees are not participating adequately. Targeted, personalized communication with easy enrollment cards, small prizes and incentives (they must be kept small to avoid ERISA issues), mandatory enrollment meetings on paid time, and tools that teach employees how to save can all help with this effort.
- Make it one of each supervisor's goals to achieve a benchmark average participation rate in their group. If supervisors have a performance expectation to educate employees about 401(k) plans and saving for retirement, have received adequate training to do so, and discuss increasing contributions with employees especially at raise time, they can have a substantial impact on plan participation. Supervisors can be rewarded for having high group participation levels.
- Make your match go further. The results of several studies demonstrate that a match has some interesting effects:
- Low-paid employees tend to contribute up to the "focal point" created by the match limit. For example, if you match 50 percent to 6 percent, they will contribute at 6 percent of pay. They are, however, the group most influenced by the matching dollars on the table.
- Middle-income employees will often lower their contributions a little and offset that contribution reduction with the match. For example, a participant who might be willing to contribute 10 percent if no match were available will lower his/her contribution to perhaps 7 percent if a 3 percent match is available.
- Highly-compensated employees, by and large, are not influenced nearly as much by the match as they are by the tax advantages the 401(k) provides.
Just changing your matching structure without increasing the dollars involved can drive behavior. For example:
- If your current match is 50 percent of the first 4 percent of pay contributed, you will probably find a large number of non-highly compensated employees contributing at the 4 percent level.
- If you were to change that match structure to 25 percent of the first 8 percent of pay contributed and couple that move with effective education, your plan would most likely see an immediate migration toward the 8 percent of pay contribution level.
If you do decide to make your match richer, it's best to do it in a way that creates an incentive for desired employee contribution levels. Retirement plan experts say that employees need to save at least 15 percent of pay through their prime earning years, according to the Employee Benefit Research Institute. So, in an ideal world, a great matching scenario might be 50 percent of contribution to 10 percent of pay to bring the employee to that desired 15 percent overall contribution amount. However, economic conditions play a big part in whether such an approach is feasible.
- Institute automatic enrollment, and not just for new hires. The most proven way to boost participation is to institute automatic enrollment for all employees, not just those newly eligible to participate in the 401(k) plan. A recent survey showed that employers who enroll only newly eligibles see, on average, only a 1 percent increase in participation.
Because so many employees just don't take action when left to their own devices, automatic enrollment for all employees can easily increase participation rates from the typical high-60 percent range into the 90 percent or higher range. Some employers automatically enroll all non-participating employees once a year, even if the employees opted out during the prior automatic enrollment cycle.
- Institute automatic increases. One of the drawbacks to automatic enrollment done by itself is that employees who are automatically enrolled actually have a lower contribution rate than those who voluntarily enroll. This is because the most used automatic enrollment level is 3 percent of pay, where the average voluntary enrollment percentage is 5.4 percent of pay. Instituting automatic increases of, for example, 1 percentage point per year until the participant is contributing at 10 percent of pay avoids this issue. Some employees will opt out, but the vast majority will stay at the higher contribution level.
- Keep it simple. Again, studies show that a large array of investment choices overwhelms participants and that participation drops off as the number of investment choices increases. For the vast majority of participants, automatically enrolling them, automatically increasing contributions, and automatically using a target date fund and/or risk-based portfolio, provides a way for them to "set it and forget it" with little or no effort needed on their part. This approach will most likely have the best impact on participation.
Judy Simons, CPC, QPA, QKA is a senior consultant and vice president, and oversees regulatory compliance functions, at TRI-AD, a provider of employee benefit administration services. She has many years of experience designing, administering and consulting for defined benefit pension plans and defined contribution plans including 401(k), profit sharing, money purchase, target benefit pension, stock bonus and employee stock ownership plans. Valerie Gieseke, SPHR, is a senior communications consultant at TRI-AD.
Reposted with permission
Source: TRI-AD Newslink, January 2009
(This article should not be construed as tax or legal advice.)
Related Articles: SHRM Online:
Clearing the Annual 401(k) Compliance Test Hurdle, SHRM Online Benefits Discipline, March 2007
The Business Case for 401(k) Automatic Enrollment, SHRM Online Benefits Discipline, July 2008
Related Article: External
Improving Nondiscrimination Test Results, PlanSponsor.com, March 2913
Using the Safe Harbor 401(k) Plan Top-Heavy Exemption, SunGard Relius, July 2012
401(k) Plans Face Disparity Issue, Wall Street Journal, November 6, 2008
SHRM Online Retirement Plans Resource Page