Cash or 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 retirement savings.
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
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
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
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
| 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