Corrective Distributions: Make them a thing of the past!
Have you ever needed to make corrective distributions in your company 401(k) plan? if your service provider has not addressed this problem with you, maybe it is time to make a switch? No time like the present to consider this dilemma and help employees achieve their retirement readiness goals.
Here is a brief review of the basics. Traditional 401(k) plans have required annual non-discrimination testing to make sure that non highly compensated employees (non-HCEs) contribute a proportional amount as compared to the highly compensated employees (defined as employee making over $130,000 in 2020). The problem is that often a company fails one of the two annual tests, requiring distributions back to the HCEs. These distributions are taxed to them at ordinary income rates.
Why is this important? It means that non HCEs are contributing too little and that the HCEs are not able to save as much as they attempted to in any given year. Besides being an outright hassle administratively, this situation is a problem because it likely means that the non-HCEs and the HCEs are not taking full advantage of this benefit which could impair their retirement savings in the long run.
1. Switch to a Safe Harbor Plan
A Safe Harbor 401(k) plan is specifically designed to create a proportional balance of savings between non-HCEs and HCEs. Non-discrimination testing is avoided which saves time, money and effort keeping the plan compliant. Safe Harbor plans require employer contributions and you can read about the options.
Employer contributions made into Safe Harbor plans are a tax deduction for the company. This can be a compelling alternative for a business owner that would otherwise forced to take a corrective distribution and taxed personally at ordinary income rates.
Deadlines: October 1 to set up a Safe Harbor plan in the current year or December 1 to set up a Safe Harbor plan next year.
2. Conduct Employee Investment Education Sessions
Do you have a 401(k) investment professional that offers investment education to your employees? If not, you should get one. We have found these sessions to be very helpful for explaining the basics about investment options and the significance of saving as much as possible for retirement. The goal at every company should be full employee participation. Online education is good, live education is better, and the combination of live and online education is by far the best option of all.
3. Add Auto Enrollment Feature to the plan
The auto enrollment feature basically structures the company 401(k) plan to require employees to opt-out instead of to opt-in. The employer establishes the contribution rate automates the pre-tax deduction out of each employee’s paycheck. Each employee can opt out as well as increase or decrease the rate. Keep in mind the SECURE Act gives companies a $500 tax credit each year for three years on new 401(k) plans as featured here.