401(k) plans are more popular than ever. They allow eligible employees to avoid current income tax on payroll-deducted savings, this year up to $10,500. The earnings on those savings also escape income tax until they are distributed. Particularly in a very competitive, full-employment environment, 401(k)s help employers recruit and retain good employees.
But many employees, especially those who are relatively low-paid, decide against 401(k) participation because they need every dollar they earn to met their living expenses. And, ironically, their opting out can hurt highly compensated employees, including the owners of businesses.
Two tricky tax tests - the "actual deferral percentage" test and the "actual contribution percentage" test - limit the right of high-paid employees to fund their 401(k)s. In the worst of cases, highly compensated employees are shut out of the benefit entirely. Yet, several planning strategies can prevent this result and benefit both the company and its employees.
One such strategy is "automatic enrollment" and it works this way: the 401(k) plan is written to "assume" that all employees want to participate until they declare otherwise. The level of participation that's usually set is 2 or 3% - high enough to help build retirement savings in a meaningful way, especially if the employer matches employee contributions, but small enough not to hurt most employees.
Experience indicates that automatic enrollment results in just about everybody staying with the plan and benefitting from it. It may also have the effect of allowing all high-paid employees to participate at or near the max.
As good as the automatic enrollment sounds, it raises some questions worth exploring with legal counsel. These include:
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.