Avoid Nondiscrimination Nightmares by Increasing Retirement Plan Participation

You might have the best retirement plan available, but if employees aren’t participating, what’s it worth? The following plan changes could make your plan more attractive to all employees.

Nondiscrimination rules prohibit top-heavy plans, or plans that involve too many high-income earners and not enough low income earners. It’s usually easier for high-income employees to set money aside because they have more free cash. Low-income earners often have to make tougher decisions, such as whether to save a little this pay day or to make the rent or mortgage payment on time.

So what can you do to encourage your employees — all of them — to commit to a retirement savings program?

1. Offer a 401(k) plan and discuss its advantages:
   • Contributions are made with pre-tax dollars, which lowers the income tax bill each year. Earnings are not taxed until they are withdrawn, and since many employees move to a lower tax bracket after retirement, taxes will take a smaller bite then.
   • Matching employer contributions, if you decide to make them, help employees’ savings grow faster.
   • Automatic payroll deduction makes saving easy. Employees have only one advertised chance a year to decide not to save for retirement. If they are saving on their own, they have a chance to make the wrong decision every pay day.
2. Offer automatic enrollment. Enrolling employees automatically in a 401(k) plan essentially switches the retirement savings decision from opt-in to opt-out. The U.S. Treasury Department notes that this creates a “positive presumption” in favor of saving — even though the employee must be given adequate notice and an opportunity to opt out. The Treasury Department says case studies show that automatic enrollment has a positive effect on participation — particularly among low- and moderate-income workers.

   Unless employees decide to make their own investment decisions, contributions are invested according to program terms.

3. Make it simpler to borrow against the plan. 401(k) plans have a loan provision that allows investors to borrow against their savings in times of need. While financial experts generally say that borrowing against a 401(k) works against the ultimate goal of saving for retirement, the ability to borrow cash from yourself can be a lifesaver.

   And knowing the money is not locked up until they reach a certain age may encourage people to save. In fact, a study by the federal Government Accountability Office showed that allowing loans increased participation in 401(k)s and increased the size of contributions, particularly among lower-income employees.

4. Give them confidence with a lifecycle fund. Selecting among funds to create and maintain diversity of risk can be a daunting task for employees, even with the narrowed choices of a typical 401(k) plan.

   Lifecycle funds relieve some of the pressure. These are 401(k) funds that automatically diversify a participant’s assets according to a planned retirement date.

   There are two types of lifecycle funds. In a target-date fund, a manager, using a standard defined by the plan, gradually shifts investments from aggressive to conservative as the employee ages. In a target-risk lifecycle fund, the employee/investor decides the level of risk he wants in the fund and the manager adjusts the holdings to create that risk. The employee can ask that the risk level be changed as time goes by.

   Lifecycle funds do have drawbacks, and their one-size-fits-all approach might not work for certain individuals. Still, employees intimidated by the selection process might find lifecycle funds an inducement to save. And savings — even with drawbacks — are better than no savings at all.