PENTEGRA RETIREMENT SERVICES QUALIFIED PLAN 401(k) PLA AN DESIGN Building successful outcomes begins with effective plan design
BUILDING A SUCCESSFUL 401(k) GETTING IT RIGHT How do you measure the success of a 401(k) plan? Success is typically defined in terms of participation rates, deferral rates and overall asset allocation. But are you considering whether your participants are making the best use of your 401(k)? Is the plan able to help them meet their retirement goals for financial security? With the 401(k) becoming the sole retirement plan for many employees, real plan effectiveness should be measured not just in terms of overall plan metrics, but more importantly, based on whether participants are on track to succeed. How do you ensure that success? Building a successful plan starts with smart plan design that ensures that every feature is designed to maximize participant behavior. SMART PLAN DESIGN THE KEY TO SUCCESS Effective plan design is more than just administrative services and fund choices. It starts with understanding a company s culture, demographics and benefits philosophy and a dialogue that provides a framework for your plan objectives. Key considerations what is your management approach and compensation strategy? Where does your organization fit comparatively to peers? What other types of retirement programs do you offer? Are all of your plans working in tandem? Understanding where a company is positioned in terms of both strategy and existing programs helps to incorporate plan features that will engage employees, and ultimately, shape the way they use the plan to build financial security. MAXIMIZING PARTICIPATION TAKE A LOOK AT ELIGIBILITY REQUIREMENTS Strong participation rates are the first step in making your plan a success. Participation rates start with eligibility features that make it easy for participants to take advantage of your plan from day one and participate in the plan from point of hire. Keep in mind that this does not necessitate offering a match to new hires. It just makes it easy to start payroll deduction immediately, and get employees into the habit of saving through the plan. As an added bonus, allow new hires to make rollover contributions to the plan, and provide an easy way to keep them from spending lump sum distributions. Generally, the law permits establishing a maximum age of 21 and a service limitation of one year. Although a delay in participation may reduce short-term costs, it will make the 401(k) plan less attractive to prospective employees. Make it as easy as possible for employees to enroll in the plan to maximize participation rates. The initial orientation of a new hire presents an ideal time to do this. Using online enrollment tools makes it even easier. CONSIDER THIS: DUAL eligibility requirements can help boost participation rates. For example, set eligibility requirements so that all employees become eligible shortly after their date of hire, and require a longer waiting period for employer contributions. 2
SERVICE REQUIREMENTS FOR EMPLOYEES TO BE ELIGIBLE TO MAKE CONTRIBUTIONS TO THE PLAN BY PLAN SIZE Plan Size by Number of Participants Eligibility 1-49 50-199 200-999 1,000-4,999 5,000+ All Plans None (Immediately Eligible) 34.9% 45.7% 60.9% 73.8% 76.2% 60.3% 3 months 24.0% 17.8% 16.1% 14.9% 12.2% 16.6% 6 months 15.5% 12.4% 6.9% 5.0% 4.1% 8.2% 1 year 25.6% 19.4% 12.1% 3.0% 5.4% 11.9% Other 0.0% 4.7% 4.0% 3.5% 2.0% 2.9% 100% 100% 100% 100.2% 99.9% 99.9% Source: PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans TAKE ADVANTAGE OF ONLINE ENROLLMENT Online enrollment is quickly becoming the preferred way to enroll participants in a 401(k) plan. The process takes place in four simple steps. The participant logs on to Pentegra Online, changes their PIN, elects a deferral percentage, makes an investment election and enters beneficiary information. Why use online enrollment? Online enrollment is a better process for plan sponsors and participants alike. Participants are enrolled faster. It is more convenient, and there are fewer errors. WHAT ABOUT AUTOMATIC ENROLLMENT AND CONTRIBUTION SOLUTIONS? Automatic enrollment basically provides that eligible participants will be automatically enrolled in their company s 401(k) unless they take action to opt out or choose an alternate contribution percent. Research shows that automated solutions such as Automatic enrollment affect participant behavior and tend to have a positive impact on plan participation. Today, according to the 55 th Annual Profit Sharing Council of America (PSCA) Annual Survey of Profit Sharing and 401(k) plans, nearly 46% of plan sponsors offer auto enrollment. Automation has become standard in many Defined Contribution (DC) Plans. Studies show that if people default in, they stay in. 1 Keep in mind however that ongoing education is key when it comes to automatic enrollment to remind younger employees in particular of the need to increase deferral rates over time and to take an interest in investing their account balance. 1 Dallas Salisbury, Employee Benefits Research Institute (EBRI) 3
PERCENTAGE OF PLANS WITH AUTOMATIC ENROLLMENT BY PLAN TYPE Plan Size by Number of Participants 1-49 50-199 200-999 1,000-4,999 5,000+ All Plans For All New Hires 6.9% 33.1% 37.6% 52.4% 47.3% 37.5% For All Non-Participants 5.3% 3.8% 8.8% 10.7% 11.5% 8.4% Percentage of All Plans That Have Automatic Enrollment Source: PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 12.2% 36.9% 46.5% 63.1% 58.8% 45.9% INCREASING DEFERRAL RATES Do your employees truly understand the benefits of deferring on a pre-tax basis for accumulation of savings? If your plan offers a matching contribution, are they contributing at a rate that provides a maximum level of employer contribution? Are they contributing at a rate that allows your highly compensated employees to maximize their contributions to the plan? Are they contributing at a rate that will meet their retirement goals for financial security? Research demonstrates that plans that offer company contributions have higher participation rates than plans that don t. According to the PSCA Survey, the average pre-tax deferral rate for Non-highly compensated employees was 5.2%, and the average deferral rate for highly compensated employees was 6.4%. If your plan allows participants to contribute at a fixed dollar rate vs. a percentage of salary, keep in mind that participants who contribute at a fixed dollar rate are likely to stay at that level, while participants who contribute a percentage of salary will be increasing their contributions each time they see a salary increase. CONSIDER THIS: If you are using an automatic enrollment option for your plan, when setting the default rate for contributions, consider an annual 1% increase in the contribution rate to help participants save more over time. 4
AVERAGE PERCENTAGE OF SALARY DEFERRAL FOR ADP-ACP TEST RESULTS FOR ALL PLANS Contribution Type Pre-Tax 401(k) 5.2% 6.4% After-Tax Roth 3.7% 4.9% Lower-Paid Higher-Paid After-Tax 401(m) 2.5% 2.8% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% Percentage of Salary Deferral Source: PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans CATCH-UP CONTRIBUTIONS Catch-Up contributions allow participants that reach age 50 before the calendar year is over to make additional contributions on a pre-tax basis. Like 401(k) deferrals, catch-up contributions are indexed for inflation. Over 98.5% of all DC plans permit catch-up contributions for participants over age 50, but less than 25% of participants over age 50 take advantage of the opportunity. (PSCA) Data Source: Profit Sharing/401(k) Council of America 55 th Annual Survey of Profit Sharing and 401(k) Plans 5
EMPLOYER CONTRIBUTIONS One of the most impactful features of a 401(k) plan is an employer matching contribution. The majority of 401(k) plans offer a matching contribution 81.6% of 401(k) plans provide a match on participant contributions, and 55% provide a non-matching company contribution. 2 Of plans with company matches, the most common matching formula is 50% per $1.00 of salary, most commonly up to the first 6% of pay, with 47.8% of plans using this type of matching formula. 3 If your plan offers a matching contribution, are your participants contributing at a rate that provides a maximum level of employer contribution? While many plans often use standard formulas 50% up to 6% of pay or 100% up to 3% of pay, and these formulas work well in many instances, consider using employer matching contributions as a way to incent participation, and structure your matching formula to do so. Employees do maximize their matching contributions. Extending the matching incentive will often result in higher deferral rates and ultimately, better retirement readiness. For nearly the same benefit dollars, you can use a 25% up to 12% of pay formula, or a 30% up to 10% of pay formula. Roll out the new formula in conjunction with a retirement education program to help employees see the value in making the most of the new match. CONSIDER THIS: Are your Highly Compensated Employees able to defer the maximums permissible? Is your matching formula designed to help them do so? 2Data Source: Profit Sharing/401(k) Council of America 55 th Annual Survey of Profit Sharing and 401(k) Plans 3Data Source: Profit Sharing/401(k) Council of America 55 th Annual Survey of Profit Sharing and 401(k) Plans 6
MATCHING FORMULAS USED IN PLANS CENTS MATCHED PER $1.00 PERCENTAGE OF PLANS Less than $0.25 per $1.00 1.4% $0.25 per $1.00 13.5% on the first 4% 3.7% on the first 5% 1.1% on the first 6% 5.6% other 3.1% More than $0.25 and less than $0.50 per $1.00 3.7% $0.50 per $1.00 47.8% on the first 3% 6.5% on the first 4% 5.1% on the first 5% 3.4% on the first 6% 26.7% on the first 7-8% 1.7% on the first 10% 1.7% other 2.8% More than $0.50 and less than $1.00 per $1.00 4.2% $1.00 per $1.00 28.1% on the first 2% 2.2% on the first 3% 5.3% on the first 4% 5.1% on the first 5% 4.2% on the first 6% 7.0% other 4.2% More than $1.00 per $1.00 1.4% 100.1% Source: PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans Note: 5.0 percent of companies match up to a specified dollar amount rather than a percentage of pay. 7
A WORD ON SAFE HARBOR MATCHING FORMULAS As a general rule, a 401(k) plan must satisfy certain non-discrimination requirements. Safe Harbor formulas provide alternative, simplified methods of meeting the nondiscrimination requirements by offering certain minimum employer contribution formulas for 401(k) plans. Adopting a safe harbor 401(k) plan design allows an employer to avoid discrimination testing of employee elective deferrals and/or employer matching contributions (ADP/ACP testing). Based on your employee demographics and how your employees are using your plan, the Safe Harbor approach may be a good option if you want to avoid discrimination testing, allow HCE s to maximize their contributions and ensure that the plan provides all employees with a base of retirement savings. Approximately 21.5% of plans use a safe harbor matching formula and 9.0% use a safe harbor non-elective contribution. 4 SAFE HARBOR 401(k) COMPARISON CHART Safe Harbor Non-Elective Contribution or Safe Harbor Matching Example Safe Harbor Option (without Qualified Automatic Contribution Arrangement )* 3% or 100% up to 3% of deferral 50% from 3% to 5% of deferral 5% deferral 4% Safe Harbor match Safe Harbor Option (with Qualified Automatic Contribution Arrangement )* 3% or 100% up to 1% deferral 50% from 1% to 6% deferral 5% deferral 3% Safe Harbor match Maximum Required Safe Harbor Match 4% of Compensation on 5% deferral 3.5% of Compensation on 6% deferral Vesting 100% Immediate 100% after 2 years Qualified Automatic Contribution Arrangement Annual Non-Discrimination Testing (ADP/ACP) Top Heavy Rules Not Required Not Required Top-heavy rules apply. May be exempt if only deferrals and Safe Harbor contribution is made (annual determination) Required initially at 3%, with 1% annual increases (to 4%, 5%, 6%) Not Required Not applicable Safe Harbor Notice Required Required QACA Employee Notice Not Required Required Qualified Default Investment Alternative ( QDIA ) Notice Not Required Only needed if plan utilizes QDIA *A QACA is a Qualified Automatic Contribution Arrangement which combines a Safe Harbor Plan with an Automatic Enrollment Plan 4 PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 8
VESTING 38.9% of plans provide immediate vesting for matching contributions, while 23.93% provide immediate vesting for profit sharing contributions. Among plans that do not have immediate vesting, graduated vesting is the most common arrangement for all contribution types 5. Often plans will apply different vesting schedules to different contribution sources. IS A ROTH FEATURE RIGHT FOR YOUR PLAN? A Roth 401(k) option combines the features of a traditional 401(k) with a Roth IRA, providing employees with a potential source of tax-free retirement income. The key differences between a traditional 401(k) contribution and a Roth 401(k) contribution center on the tax status of both contributions and withdrawals, along with the rules governing rollovers. Unlike a traditional 401(k) contribution, Roth 401(k) contributions are made on an after-tax basis. Traditional 401(k) contributions reduce a participant s income for federal and (usually) state tax purposes at the time contributions are made and grow on a tax-deferred basis until the participant takes a distribution, which is treated as ordinary income. Roth 401(k) contributions and investment earnings, on the other hand, are tax free upon withdrawal as long as the employee has maintained the Roth 401(k) account for at least five years and has attained age 59 ½. The Roth 401(k) may offer advantages to those who are currently in a low tax bracket but who expect to be in a higher tax bracket after retiring. Another benefit the Roth 401(k)'s tax-free withdrawals can help highly paid workers manage their tax situation in retirement. For most people, the main reason to contribute to a Roth 401(k) is to let the money grow tax-free. No one knows what the tax rates will be in the future, so it may be beneficial to hedge the taxable contributions and earnings in a traditional 401(k) with earnings in a Roth 401(k) that can be withdrawn tax-free. That said, why wouldn t you offer a Roth feature under your plan? PLAN ACCESSIBLITY LOANS AND WITHDRAWALS There are two schools of thought on accessibility to 401(k) accounts one that advocates that access to plan accounts is a bad thing and that a 401(k) plan shouldn t be used like a saving account, and others that feel that participants will contribute more if they know they can access their money. 5 PSCA s 55th Annual Survey of Profit Sharing and 401(k) Plans 9
Most plans allow participants to access their account using withdrawal and loan provisions approximately 90% of plans offer loan and hardship withdrawal provisions 6. Using a plan s withdrawal feature whether through an after-tax withdrawal if a plan permits after-tax contributions, or through a hardship withdrawal provision comes with obvious tax penalties. Recognizing this, loans are the better way for participants to do this the participant pays themselves back and makes their account whole by making payments through payroll deduction with interest. By limiting the number of total loans outstanding at any given time and by charging participants loan initiation and maintenance fees you can be assured that they are treating the plan as a retirement plan. INVESTMENT STRATEGY VS. INVENTORY When it comes to plan investments, is yours based on a true strategy, or is it simply an inventory of funds? When it comes to plan investments, more is not always better. In fact, less is more. The majority of 401(k) plans contain far more equity options than are required to create a diversified equity portfolio 7. The result? Choice overload, which can leave participants overwhelmed to the point where they simply default to the most conservative investment options. In doing so, they may sacrifice the opportunity for wealth accumulation most retirement investors should seek. When it comes to retirement plan investing, clarity of investment choices and ease of use should be more of a priority than how many funds are available. The average defined contribution plan has a total of 19 investment options, and roughly 16% of plans offer a self-directed brokerage option 8. 95.6% of plans offer the same fund options for both participant and company contributions. Participants often associate more fund choices with more research, more consideration, and more work for them. Streamline your fund lineup to help participants make simpler and more educated asset allocation decisions. AVERAGE NUMBER OF INVESTMENT FUND OPTIONS BY PLAN SIZE Plan Size by Number of Participants Number of Funds Available for Company Contributions 1-49 50-199 200-999 1,000-4,999 5,000+ All Plans 23 22 18 18 17 19 Number of Funds Available for Participant Contributions 22 22 18 18 17 19 6PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 7PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 8PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 10
WHAT ABOUT TARGET DATE FUNDS? If Target Date Funds aren t in your current investment lineup, they should be. Besides being a great choice for a Qualified Default Investment Alternative, these funds are particularly suited to participants who want a diversified portfolio in a single fund, are inexperienced investors who prefer to have their asset allocation decisions professionally made and are looking for a time horizon-based investment strategy with a single decision. Investors overwhelmed by too many funds from which to choose may make less-than-optimal decisions at best, no decisions at worst. The target date approach eliminates the choice overload phenomenon that can result from too many options. The availability and use of target funds continues to grow 68.6% of plans now offer them. The average allocation of plan assets in target date funds is 12.4%, up from 4.5% in 2007. 9 A WORD ON FIDUCIARY RISK AND INVESTMENTS Defined contribution plans present a significant level of fiduciary risk and the governance of a retirement plan including its investment options should reflect this. When you are designing an investment lineup, fiduciary risk should be top of mind. As a plan investment fiduciary you have to establish the investment policy, decide on the appropriate asset classes and then select the investments for the participants selecting a combination of investment funds that perform well individually and that fit together properly. Outside experts must be prudently selected and monitored, since fiduciaries have the duty to document their work when selecting and monitoring investments and service providers. That s why good plan design includes developing an investment policy statement for the selection and monitoring of plan investment options. 88.8% of plan sponsors report having an investment policy statement 10. Defining the criteria to be used in the selection and monitoring process and documenting your compliance with those guidelines will also go a long way toward protecting you from liability. The purpose of an Investment Policy Statement is to set forth the goals and objectives of the investment options that are available to the plan participants. It should provide a framework of guidelines for monitoring and evaluating the plan's investment options, including a procedure for terminating and replacing any underperforming fund. CONSIDER THIS: Once you have an investment policy in place, on an ongoing basis, ask yourself: is the plan s investment strategy aligned with the investment policy? Are you satisfied with performance relative to benchmarks? The menu of investment options, along with the experts you retain to assist you must be evaluated periodically, and a formalized written investment policy statement that defines the criteria to be used is a valuable tool for ensuring proper evaluation. 9PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 10PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 11
REINFORCING SAVINGS WITH EFFECTIVE PLAN EDUCATION Education alone does not drive participant behavior. Even the best communications can t combat poor plan design. Make sure that the plan design you choose supports the participant behavior that you wish to influence, and build a communication strategy around that. Know that there is nothing more effective when it comes to influencing participant behavior then on-site education. When employing communication strategies, think about what type of participant behavior you wish to influence. The most common reasons for providing plan education are to increase participation (81.4%), to increase appreciation for the plan (74.7%) and to increase deferrals (75.6%) 11. Beyond that, is asset allocation a concern? Do participants need an investment education refresher? Have they done any retirement planning? Do participants understand how all of their retirement plans work in tandem, and how they should best use the plans to help them achieve their retirement goals? CONSIDER THIS: Are your retirement programs illustrated on a combined benefit statement? Get the most bang for your benefits buck by incorporating all of your retirement benefit plans on a single statement. USING PLAN TOOLS Online account access tools are one of the most effective ways for participants to take a more vested interest in their plan. Ask yourself, have your participants developed a comfort level in accessing your plan s participant website for account access? Are they using the rebalancing and account realignment tools at year-end? Even more importantly, are they using online financial planning tools? Online tools offer an easy way to engage employees early and often about retirement planning, touching employees throughout the key phases of participation in a retirement program: awareness of the benefits, enrollment, retirement investment basics and ongoing monitoring and planning. Encourage the use of these tools to help employees map out a strategy. Participants can t measure whether they are on track to meet their retirement planning goals without first taking the steps to determine what the goal is. What s more, a number such as 5% or 6% percent of salary saved and employer matching contributions don t have a real context for participants without showing them how this translates into real income at retirement. Encourage the use of financial planning tools to help your participants do this in particular, tools that provide guidance and advice. Perhaps one of the most frequently heard participant requests for help is, How should I invest my savings? Financial planning guidance and advice tools can answer this question, educating participants with respect to their investment options, recommending specific asset class allocations, recommending specific funds within those asset classes and amounts to be invested in each, and making it easy for participants to implement these decisions by recording the decisions to the recordkeeping system. 11PSCA s 55 th Annual Survey of Profit Sharing and 401(k) Plans 12
WHY USE ADVICE/GUIDANCE BASED TOOLS Advantages to Participant Objective investment advice Allows participants with varying investment experience levels to make informed choices Educational Advantages to Plan Sponsor Improved participant satisfaction with a tool that addresses frequently expressed participant want specific investment recommendations Helps satisfy participant education requirements When all is said and done, a plan s success is measured by how effectively a participant is able to meet their retirement income replacement goals. Good providers know that successful plan design is a partnership between the sponsor and the retirement plan provider. For more information on plan design options or our plan design consulting services, please contact us at 800-872-3473, or visit us at www.pentegra.com. 13