401(k) Plans Need More Planning

by | Aug 14, 2017

Authored By – Ronald E. Lang, Principal – Atlas Wealth Management, LLC
401(k) Service Providers

There are many companies out there with 401k Plans, but most of them do not research and consult into “why” the plan needed to be setup, “how” it should be setup and “who” would benefit from this structure. Many of these plans were setup quickly to get started fast, but never revisited. There are so many things to consider when setting up a 401k plan, but flexibility and high participation rate are the two keys to a successful and long sustaining 401k plan.

One of the first things to think about is “why” you are you setting up this plan. Is it for ownership and top management, to attract and retain employees, to reward and motivate them or is it because all your competitors offer one so you thought it would be a good idea? It is possibly for one, some, most or all of the previous reasons. If you are looking at the long-term, the answer should be “all of them”. Building a business has so many components to its success, thinking about and considering a 401k plan typically is not one of the first items that one considers. However, it is an important ingredient to the overall recipe. As you know, when trying to setup, build and expand any business today, it is the people that are the gas to the business engine. It takes several reasons for the “best” talents to consider joining your company. In addition to the job opportunity, the compensation package can make or break a decision to choose your company over one of your competitors. As each day passes, the retirement crisis gets worse and most people feel that they will never be able to save enough to achieve financial freedom. The last thing they want to think about when they join a company is whether or not there will be a plan to help them save for retirement.

When you are thinking about the “why” for setting up a 401k plan, remember that it is all about the people that will be participating in the plan. True, ownership and key executive members may have more opportunities than the average salaried individual to maximize their annual contributions. Hopefully a company match will be considered to entice participants to participant in addition to maximizing what they can to the plan in order to take advantage of the match.

401k Plans don’t need to be complex or difficult to understand, but the “right” plan can make the difference in who decides to accept a job offer with your company and “why” people may want to stay with your company. As you know, it costs a lot more to search and hire someone than it does to train and retain a valued employee.

Next we will focus on the “how” when it comes to 401k Plan Structure. The right structure for your company can make the difference and lead it to its success. Here are a few items to think about regarding the components of the right structure to consider for your company:

  1. 401k Plan, Roth 401k Plan or hybrid? Offering a Roth 401k Plan is very important, especially to those who don’t want to pay any taxes once they decide to take withdrawals penalty-free after the age of 59 ½ .
  2. In-Service Distributions can offer flexibility to participants if they need to withdraw funds and not take a loan against their account. It will also offer flexibility to those participants who may want to diversify their qualified retirement funds into a Fixed-Index Annuity or other safe alternative investment. Unfortunately, several plans are limited in their asset choices and make decisions more difficult when economic swings occur. Having the option is critical to the participant and the choices they need to make for their financial future.
  3. Automatic Enrollment can be a way for the company to show how serious they are about getting the participants involved in saving for their retirement. Of course they could always opt out, but the company’s choice to have Automatic Enrollment can demonstrate loyalty to the participants and the long-term orientation of the company.
  4. Hardship Withdrawals and Loans should be standard with every plan. These are not used very often, but again, flexibility is key to a successful plan.
  5. Vesting Schedule – This one is a bit tougher to decide on for the company’s plan. Of course the participants want the match to be 100% vested as soon as it is received, but with the average tenure in a company hovering around 4.6 years, you want some loyalty from the participants. Sometimes a 3-5 year vesting schedule works. You need to look at your employee structure, compensation plan, business plan and cash flow to determine which vesting schedule will work best for your company in the long-term.

These are just some suggestions for a possible structure or change of structure for your company. Remember, flexibility and education is key to a higher participation rate and a successful 401k Plan.

401k Plans are setup for many reasons; one of them being the compensation of ownership members, key executives, and performers. If you are under 50 years old, your 401k account can be maximized at $53k per year ($59k if you are over 50 years old). Your maximum deferred contribution is $18k per year ($24k if you over 50 years old), not including any company match. There is a way to use the 401k Plan to maximize the annual deferrals and Part 3 will focus on the “who” when it comes to 401k Plan compensation. The right compensation towards your 401k Plan can make the difference to its success.

For example, if your company has a $1M profit, there are a number of things you could do with that surplus of funds. Below is a sample list:

  1. You could distribute profits to ownership. The ownership is entitled to their share of profits, but that would create a tax liability situation.
  2. You could reinvest some, most or all of the profits into the business for Research & Development, Marketing, Expansion, Hiring, etc.
  3. Another consideration is to take a portion of the funds. For this example let’s say you take $400k of the $1M in profit and distribute it as a bonus towards ownership and key performers’ 401ks. Many times, companies will offer the option to take as a “bonus” towards wages, put those funds towards the 401k or a combination of both. This does a few things:
    1. You can suggest putting their funds toward the 401k and maximize it at $53k ($59k if they are over 50). This helps to contribute more towards retirement and the funds will grow tax free.
    2. If you distribute the $400k as a bonus to ownership members and key performers, that is $400k “less” that is taxable. Your new taxable amount is $600k ($1M – $400k = $600k). This is a tremendous benefit of having a 401k plan, but it is an underutilized benefit many companies do not take advantage of most years.

When you have healthy and windfall years for profit, you need to be smart about your money. You may want to create a cash war chest for future economic downturns or use the money to expand your business through marketing and hiring. Understanding your business cycles, economic conditions and business needs will help you determine how to properly compensate ownership and key performers. Also, consult with your CPA on tax implications to maximize your cash surplus. Remember, paying taxes is a good thing because it means that you are profitable, but keeping ownership and key performers happy will drive your business to the next level.

You can contact Ronald Lang at (888)403-9400