Viewpoint: Rebate Checks

Boost Participation in 401(k) Plans To Avoid The Dreaded "Rebate" Check For Highly Compensated Employees

A bank error in your favor…a rebate on the purchase of a car…a tax refund from the Internal Revenue Service (IRS). Most of us welcome getting money back in one form or another.

But many highly compensated executives are less than thrilled when they have to take back money they have already contributed to their company’s 401(k) retirement plan because it fails to meet nondiscrimination rules. Failure typically occurs when the gap between what highly compensated employees defer on average and what non-highly compensated employees defer on average exceeds IRS guidelines.

Unfortunately, this is happening with growing frequency. The 401(k) Profit Sharing Council of America (PSCA) reported that 58% of all non-safe harbor plans failed their non-discrimination test in 2008, an increase of 20% from the previous year.

Encouraging employees to contribute to retirement plans, especially workers who are modestly compensated, has never been tougher than in today’s recessionary economy. Employers both large and small have reduced or eliminated matching contributions, removing what is perhaps the biggest incentive for most people to save through their employer’s 401(k) plan. And in some cases, that match reduction itself can cause a 401(k) plan to fall short of the IRS nondiscrimination requirements.

Match or no match, there are other ways to incent employees to take advantage of what may be the best opportunity available to save for retirement–alternatives that do not require any additional contributions.

Re-enrollment Meetings

Most plan sponsors conduct enrollment meetings to help educate new employees on the advantages of retirement plan savings. Many 401(k) providers have teams of trained specialists that you can call on to lead re-enrollment meetings for employees, either those who have yet to take advantage of the plan, or who have already made the decision to save, but perhaps at a less-than-optimal rate. These specialists are equipped to educate employees on the advantages of saving for retirement, promote the power of regular, long-term investing, explain the advantages of tax deferral, and demonstrate the relatively benign impact that pre-tax savings will have on employees’ paychecks.

These re-enrollment “Swat Teams” can also explain how failing to save can adversely impact quality of life in retirement, the financial foibles of relying solely on Social Security during retirement, and the effects of inflation on retirement income. The bottom line: Re-enrollment meetings can significantly improve the percentage of employees who participate in a 401(k) plan, and the rates at which they defer.

The Saver’s Credit

Another effective way to encourage retirement savings is to make employees aware of a bit of Congressional largesse. Modestly compensated employees can qualify for a special federal Saver’s Credit based on contributions to a defined contribution retirement plan or an individual retirement account (IRA). The tax credit can equal as much as 50% of their total contribution, capped at a total credit of $1,000, depending upon the level of contribution and the employee’s income.

The credit is available on a sliding scale to those who are age 18 or older, do not attend school full time, are not claimed as a dependent on another federal tax return, and whose adjusted gross income does not exceed $27,750 for single filers and for those who are married filing separately.
The income limit is $55,000 if married filing jointly and $41,625 if head of a household with a qualifying person.

Automatic Enrollment

Perhaps the most effective way to ensure employees take advantage of their employer’s retirement savings plan is to automatically enroll them in it. Nine in 10 employees participated in their employer’s 401(k) plan if their company automatically enrolled them, according to a study by Hewitt Associates. And, while automatic enrollment is not a new concept, the Pension Protection Act of 2006 provided some much-appreciated clarity and structure.

There are some requirements–and some new opportunities: Employees must be notified of the auto enrollment and they must have the opportunity to opt out. On the opportunities front, defaulted employees can now withdraw their automatic contributions from the plan within 90 day from their first deferral. Before this year, they were unable to access their contributions as easily – and many employers had hesitated to implement automatic enrollment programs as a result.

Employers who are concerned about their fiduciary liability for the investment of these defaulted contributions can now employ a qualified default investment alternative (QDIA) such as age-based or target-date retirement funds, a balanced fund, or a managed account to funnel employees’ money that is automatically deferred into the 401(k) plan. The Department of Labor recently clarified the rules on QDIAs, saying they are now appropriate for short-term investing by plans that include an eligible automatic contribution arrangement–and offering plan fiduciaries legal protections in the use of prudently selected QDIA options.

Contribution Acceleration

Finally, employers can turbo charge employee contributions to a 401(k) by employing an automatic enrollment safe harbor feature that boosts the percentage of employee contributions each year according to a predetermined schedule. Enacting such a schedule requires additional employer contributions and the required match could be subject to a two-year vesting schedule. Or, you can simply provide participants the ability to boost their annual contributions voluntarily–you might be surprised how many will take advantage of the option.

All of these incentives–re-enrollment meetings, the Saver’s Credit and automatic enrollment–can help increase contributions by employees in employer-sponsored retirement plans. The end result: you can help business owners and their highly compensated executives accumulate more money for retirement without fear of the dreaded “rebate’ check from their 401(k) plan.


E. Thomas Foster Jr., Esq., is The Hartford’s national spokesperson for qualified retirement plans. An Employee Retirement Income Security Act (ERISA) attorney, Foster works directly with broker/dealer firms to promote the sale of 401(k) programs and other qualified retirement plan products and to help them build their retirement plan business.