Friday, October 24, 2008

It's Time to Take a Look at Your 401(k) Strategy

Many 401(k) plans operate on a calendar year basis, and right now is a good time to reconsider your 401(k) options as an employer. This topic came up in a recent Local Board meeting. The discussion centered around Safe Harbor provisions, something that must be declared and communicated prior to the beginning of the plan year, and can be changed in subsequent plan years.

Safe Harbor provisions fit into the "fairness" concepts in the 401(k) statute. Congress wanted to make sure owners and executives didn't set up 401(k) plans, forget to tell their employees about them, and then take maximum advantage ( in the forms of maximum contributions and company matches) for themselves alone. So the concept of "participation testing" was implemented. Simply described, the "top heavy" and "highly compensated" tests limit the maximum participation of owners and highly compensated employees, proportional to participation of lower-paid workers. You may have had the unfortunate experience of getting a "refund" of your 401(k) contributions after the fact, due to over-contributing.

These participation tests rarely work out so those who wish to max out their 401(k) contributions can actually do so.

Let's also review the allowable maximum contributions (if not limited by participation testing). Those are $15,500 for most employees, with a "catch-up" provision of an additional $5,000 for those over 50 -- a total of $20,500 annually for that group.

And it's also a good time to point out that a Roth-style 401(k) offering is now available. If you already have plenty of pre-tax deferred income in either a 401(k) or IRA, you can amend your plan to allow participants to designate their contributions as Roth-style, meaning that despite paying taxes on the income now (at historically low tax rates), the income, dividends and growth in net asset value are tax free forever! Of course, the company match contributions, since they're deductible to the company, go into a parallel account that's considered pre-tax.

So, how can you make the most of these extraordinary opportunities for yourself as an owner? The Safe Harbor provisions allow you to make company contributions in either of two ways, thereby nullifying all participation testing. Those two ways are:

  • A 3% (of salary) match, automatic, across the board, regardless of the employee contribution, for all eligible employees. Eligibility is usually based on a waiting period after initial hire and a minimum number of hours worked in a year, as specified in your plan.

  • A specific (or better, I assume) employer match formula of:

    • 100% of the first 3% of employee contributions

    • plus 50% of the next 2% of employee contributions.

    • Thus, for an employee contributing at least 5%, the company would match 4%

In the CEBI meeting where this was discussed, one member said he had done the math, and changing his existing match formula to the Safe Harbor formula would cost him about $30,000 in additional match -- far more than the value of himself and his partner being able to max out their contributions.

A member in another meeting had mentioned that he went to the 3% Safe Harbor option one year, in lieu of pay raises. Now, said the member who had done the matching math, "That's an idea worth looking at." Note that a 3% "raise" through the 401(k) is, in fact more than 3%, considering that both you and the employee also save the combined FICA burden of 15.3%. That saves you 0.23% of salary, and the employee the same amount.

As always, these are ideas, not recommendations. Consult your own legal, benefits and/or tax advisors before taking any course of action, to ensure they are appropriate for your own specific situation.

If you do decide to amend your plan, you haven't a moment to spare -- call your 401(k) fiduciary today and be sure you understand the timeline necessary to get plan changes in place for 2009. You must get your plan amended AND provide notice to Safe Harbor- eligible employees not less than 30 days before the new plan year.

If you have some other ideas or suggestions on compensation or benefits, please click "Comment" below and share them with us.

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

1 comment:

  1. The safe harbor contributions must be one of the following:
    1) a nonelective 3% contribution based on compensation.
    2) 100% match of the first 3% deferral plus 50% of the deferral from 3% up to 5%
    The safe harbor match is always 100% vested.

    The matching formula for the upcoming plan year must be disclosed and posted for the employees at least 30 and not more than 60 days prior to the commencement of the plan year. (i.e. by Dec 2). The plan must be operated as a safe harbor plan and can then be amended up until the last day of the plan year.

    If you wish to make additional discretionary match calculations or profit sharing contributions to the plan, these may be subject to vesting schedules.

    There are also newer safe harbors for QDIA's (qualified deferral investment alternative) and automatic enrollment but the biggest change to most plans in 2009 may be the required fee disclosure of the administrator, investments and trustee.

    As always, consult your ERISA attorny for how these may apply to your situation.


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