The 401(k) world is rapidly changing. Has your 401(k) plan kept pace? Is the design of your plan still market competitive? Leading-edge 401(k) plans feature the following plan design attributes:
1. Participant investment advice. The time when all 401(k) participants have access to professional investment advice from multiple sources is here. Many recordkeepers now offer at least two types of investment advice: algorithm-based (think robo-adviser) and a more personalized version (either a proprietary option or through a firm like Financial Engines, or both). Costs range from free to 50 basis points.
2. Online education. Many progressive employers have realized that their employees need help with financial literacy. Not only will improved financial decision-making skills help them make better employee benefit decisions, but it will also help them do their jobs better. These employers are combining financial literacy/wellness education with 401(k) plan education and hiring firms to deploy online access to 10-15 minute modules. An online approach ensures that education opportunities are offered to millennial's where and when they want them – on their smart phones at a time of their choosing.
3. Auto-enrollment. With opt-out rates at less than 80%, auto-enrollment has become the solution to low participation. Note that initial auto-enrollment default contribution percentages have increased to 5% or 6% (from 3%).
4. Auto-escalation. Participants need to add at least 15% to their 401(k) accounts each year in order to retire with a retirement ready balance. Annual auto-escalation of 1% per year to at least 10% helps them get there.
5. Annual re-enrollment. Many employers are re-enrolling non-participating employees each year and defaulting their investment choices into target-date options. Use of annual re-enrollments typically increases plan participation to 90% or more.
6. A stretched match. In order to encourage a higher level of participant contributions, many employers are stretching their matching contributions over a broader employee deferral. A traditional match had been 50% of the first 6% of employee deferrals (resulting in a 3% employer match). A stretched matching contribution will provide the same 3% employer matching contribution over a larger employee deferral – 25% of the first 12%, for example.
7. Roth 401(k) deferral option. Many young participants will benefit from a contribution strategy that includes the use of Roth 401(k) accounts. After five years, balances in these accounts may be distributed tax-free (for qualified distributions). Those participants that contribute to Roth accounts for their entire careers may build an enormous tax-free balance. Also, your executive group will appreciate having the option to utilize these accounts to execute tax planning strategies.
8. Leakage management. Protecting plan participants from themselves has become an important plan design feature. One way of doing that is eliminating opportunities for leakage – reducing or eliminating plan loan and withdrawal options (unless a hardship reason exists). Loan balances are often defaulted when participants change jobs, permanently removing assets from participant retirement balances.
9. Elect to comply with 404(c). By complying with ERISA section 404(c) employers can shield themselves from lawsuits brought by participants relative to the investment options offered in the plan. Ask your investment adviser to outline what you need to do to comply.
10. Elect a QDIA. Employers electing a Qualified Default Investment Alternative receive protection from participant lawsuits relative to losses participants may suffer in the QDIA investment. Again, ask your investment adviser to explain.
Other considerations in 401(k) plan design include:
- Progressive plan designs support plan objectives which the employer regularly communicates.
- Employer profit-sharing contributions are less valuable in terms of motivating participants to contribute than employer-matching contributions. If possible, replace employer profit-sharing contributions with employer-matching contributions.
- If your employee group is small (100 employees or less) it is very likely your ownership group would benefit from using a safe harbor plan design. These plan designs provide exemptions from non-discrimination testing requirements as long as a mandatory level of employer contributions are made.
Review your plan soon and make changes this year. Most of these features cost very little to implement.
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