Perspective: A Season for Second Chances

Politicians have always been fond of second chances. 

Former presidents George W. Bush called America “the land of second chances” and Bill Clinton affirmed his belief in a “god of second chances.”

There is a parallel in the retirement plans universe. After several years of global financial turmoil, many of America’s 401(k) retirement plans have an opportunity for second chances of their own. Many financial advisers are now in a perfect position to facilitate.

Many companies that suspended matching 401(k) contributions because of the economic downturn are now restoring or planning to restore matches, according to the Profit Sharing/401k Council of America. It’s a good time for advisers to review the relative effectiveness of these retirement plans with their sponsors and consider whether or not an alternative design might prove more effective going forward.

Data from Form 5500 filings annually shows that thousands of retirement plans are plagued by a host of shortcomings. Among the most common of these tend to be low participation rates, corrective distributions, and unnecessary fiduciary risks. More often than not, though, advisers will find that business owners and other employers simply want to improve their own ability to set aside more assets for retirement, increase participation within their 401(k) plan, or both.

No doubt, second chances can be elusive. It can take decades for historians and others to revise their views on U.S. presidents. For some, the wait never ends.

But retirement plan sponsors needn’t share the same fate as Millard Fillmore, Calvin Coolidge or other forgotten chief executives. Fortunately, there are some design changes that can be adopted to help secure a second chance for an employer to accomplish retirement plan goals:

Alter the formula for matches: There is a growing debate about the relative effectiveness of the typical match on 401(k) contributions: 50% match on the first 6% of pay contributed by participants. There are variations on this theme, all of which could be improved to help encourage American workers to save more for retirement.

Some employers are now tinkering with the formula, requiring higher contribution rates to secure lower matches. For instance, plans may consider a 25% match on the first 12% of pay contributed. That would mean someone earning $50,000 a year would have to contribute $6,000 to obtain a $1,500 match, doubling the contribution rate to obtain the maximum match. Through this arrangement, plan participants are encouraged to save more with no additional cost to the plan sponsor.

Employ a Safe Harbor design: Many highly compensated business owners and executives find it difficult to accumulate sufficient assets to retire, especially if non-highly compensated employees do not participate or contribute little to their retirement plan. Contributions by and on behalf of highly compensated executives may be increased if the employer is willing to employ a Safe Harbor design. A Safe Harbor can automatically satisfy discrimination testing as long as the employer makes a 3% non-elective contribution on behalf of all employees or makes a matching contribution for elective deferrals equal to 100% on the first 3% of compensation plus 50% of compensation between 3% and 5% (for a total match of 4%).

Adopt automatic enrollment: Plan can provide for automatic enrollment for all employees provided they allow them to halt and withdraw contributions within 90 days of initial enrollment. Eligible employees are automatically enrolled in the retirement plan using a default deferral percentage and a default investment option selected by the employer.

Enact automatic escalation: As a complement to automatic enrollment, some plans also allow automatic increases in the percentage of contributions employees make to their plan each year. Automatic contributions typically start at around 4% and automatically go up by 1% a year until they reach a predetermined level, typically 10%. Employees generally must be allowed to opt out or to halt the escalation at a specific percentage rate.

These are only a few potential tactics that financial adviser can recommend to help employers revive their 401(k) plans and enhance their effectiveness. Of course, employers are advised to work closely with their legal adviser before implementing any plan changes.

Restoring matching contributions is a great restart a retirement plan but may not be enough in many cases to encourage greater participation or higher deferral rates by employees. Help plan sponsors make the most of their “second chances” by taking a fresh look at their retirement plans.

E. Thomas Foster Jr., Esq., is The Hartford’s national spokesperson for qualified retirement plans. Foster works directly with broker/dealer firms and advisers to help them build their qualified retirement plan business and educate them about industry issues.

This information is written in connection with the promotion or marketing of the matter(s) addressed in this material. This information cannot be used or relied upon for the purpose of avoiding IRS penalties. This material is not intended to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice.

Many tax planning strategies emphasize the deferral of current income taxes, on the basis that your federal income tax rate may be lower at retirement. Please keep in mind that federal income tax rates are unpredictable and may be higher when you take a distribution than at the time of deferral. Other factors, including state tax rates and your income, may also affect your overall tax rate upon distribution. Please consult with your tax advisor for individual tax planning strategy and advice. The Hartford does not predict or in any way guarantee favorable tax results.

Please note that there are additional regulatory requirements for automatic enrollment and automatic escalation.

A “Safe Harbor” 401(k) plan uses the alternative methods for meeting the non-discrimination requirements set forth in Internal Revenue Code Sections 401(k)(12) and 401(m)(11), and is subject to additional requirements, including, but not limited to, required annual contributions, initial and annual employee notices, and restrictions regarding the date of the plan’s adoption. You should direct your client to consult with their tax or legal advisor in order to determine if a Safe Harbor 401(k) plan is appropriate.

Retirement programs can be funded by group fixed or variable annuity products and funding agreements issued by Hartford Life Insurance Company (Simsbury, CT). Group variable contracts are underwritten and distributed by HSD, where applicable. HRS and HSD offer certain service programs for retirement plans through which a sponsor or administrator of a plan may also invest in mutual funds on behalf of plan participants.

“The Hartford” is The Hartford Financial Services Group, Inc. and its subsidiaries, including Hartford Life Insurance Co., Hartford Retirement Services, LLC (“HRS”), and Hartford Securities Distribution Company, Inc. (“HSD”). HSD (member FINRA and SIPC) is a registered broker/dealer affiliate of The Hartford.