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2011 could prove to be a year of significant value for plan sponsors and their employees
In December 2010, President Barack Obama signed into law an $858 billion tax bill affecting tens of millions of Americans. The extension of the Bush-era tax cuts included a one-year reduction in workers' Social Security taxes by nearly a third, from 6.2 percent in 2010 to 4.2 percent for 2011. An employee paid $50,000 would save $1,000 a year; one making $100,000 would save $2,000.
The reduction in Social Security payroll taxes is essentially a gain for American workers in their take-home pay. Sponsors of defined contribution retirement plans can take advantage of the reduced payroll deduction by encouraging employees to increase their plan contributions by a like amount, which could greatly improve their odds of saving enough for a secure retirement.
And it’s a good opportunity for plan sponsors who have not put automatic enrollment in place to do so.
Benefits to Plan Participants
Redirecting the payroll tax reduction into their retirement plans represents an opportunity for employees to make a revenue-neutral decision to increase their 401(k) or 403(b) plan contributions without affecting their take-home pay. David Wray, president of the Profit Sharing/401k Council of America,
stated that “this could have a significant impact on amounts available for retirement, especially for younger workers who will earn a compounded return on the amount for decades.”
According to tax attorney Curtis DeRoo of Kerr, Russell and Weber PLCin Detroit, anincrease in contributions to a traditional 401(k) would have the additional benefit of reducing taxable income. Because Social Security is a non-deductible expense (post-tax) and non-Roth retirement plan contributions are deductible (pre-tax), participants would experience an additional savings from federal and state income tax. And if there is a company match, they would compound their savings rate even more.
Automatic Enrollment Options
For employers who have experienced the annoying return of excess contributions (via "corrective distributions") because of failed nondiscrimination testing, the 2011 payroll reduction provides an opportunity to implement an automatic enrollment component to their plan and increase participation while minimizing the out-of-pocket expense to participants. Showing employees that an increase in their participant contributions could have no effect on their 2011 versus 2010 take-home pay makes the decision easier.
A qualified automatic contribution arrangement (QACA) under the Pension Protection Act provides a
safe harbor design that exempts plans from certain cumbersome nondiscrimination tests. Under a QACA, the automatic plan must meet certain employee and matching contribution rules, vesting requirements and notification rules. To comply with QACA safe harbor matching contribution provisions, an initial 3 percent salary deferral rate and a dollar-for-dollar match on the first 1 percent, with 50 cents on the next 5 percent of the employee contribution, are required.
Looked at another way, a 3 percent deferral amount would require a 2 percent employer match in the first year. As an alternative, the employer can provide a 3 percent non-elective contribution.
Net Participation Effect
A 3 percent employee deferral rate equates to less than a 1 percent reduction in take-home pay because the first 2 percent is a wash (resulting from the 2011 reduction in Social Security tax). Since the additional 1 percent is a pretax contribution, the net affect will be less than a 1 percent reduction in take-home pay.
Add the required matching formula on 3 percent and the net result is actually an increase in compensation redirected to participants’ retirement plans; a 3 percent deferral plus the required 2 percent employer match overcomes the approximate 1 percent reduction in pay. In other words, a reduction of less than 1 percent in take-home pay in 2011 results in a 5 percent retirement plan contribution.
Success of a plan should be based on the ability of participants to replace income at retirement. One way to achieve this goal is through greater participation with higher contribution rates.
Although the relief in Social Security tax is temporary, 2011 could prove to be a year of significant value for plan sponsors and their employees. Plan sponsors should resolve to be proactive and take advantage of the opportunities at hand.
Anthony Agbay is president of
The Agbay Group, a division of Leonard & Company. He is an independent retirement plan consultant specializing in fiduciary oversight strategies and retirement plan evaluation, and can be reached at
The above discussion does not take into account the specific tax or financial situation or needs of any specific person. Before making any decision or taking any action regarding the foregoing, you should consult with your personal tax and/or financial advisor.Leonard & Company is member FINRA/SIPC.
Top 10 Things to Do If Your 401(k) Plan Fails
SHRM Online Benefits Discipline, January 2009
Most Must Save More, Work Longer to Recover
SHRM Online Benefits Discipline, April 2009
The Business Case for 401(k) Automatic Enrollment,
SHRM Online Benefits Discipline, July 2008
Automatic Enrollment 'Safe Harbor' 401(k)s: An Exemption from Compliance Testing, SHRM Online Benefits Discipline, March 2007 (updated January 2010)
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