401(k) salary deferral plans are among the most popular retirement plans today. Nearly every financial services company —brokerage firms, banks, insurance companies — offers 401(k) plan services.
A 401(k) plan allows employees to “defer” a part of their pay. The deferred pay is deducted from an employee’s paycheck and is placed into the employer’s tax-qualified plan. Federal (and in most cases, state) income tax is not due on the deferred pay — or on the plan’s earnings — until the employee withdraws the funds from the plan.
If your organization is considering a 401(k) plan — or if it has a 401(k) plan in place that you are currently reviewing — there are several things to consider. Here is a quick checklist:
FIRST, DOES THE PLAN YOU’RE CONSIDERING OFFER FLEXIBILITY AS TO PLAN DESIGN? Most service providers offer an IRS-approved prototype plan, which can save money over an individually designed plan. But a prototype plan can be inflexible. Make sure that any prototype plan you adopt is flexible enough to meet your organization’s overall needs.
SECOND, DOES THE PLAN OFFER A BROAD RANGE OF INVESTMENT OPTIONS? Nearly all 401(k) plans allow employees to choose their own investments — usually from among several specified alternatives. The service provider you’re considering likely offers its own investment options. But what if these investment choices regularly underperform similar investments? You might want to consider hiring a service provider that allows you to use outside investments for at least some of the plan’s assets. However, you will in any event want to make sure that you will be able to meet your disclosure obligations with respect to any offered investment options – you should consult your legal advisors as to the nature and complexity of those disclosure obligations.
Note that the U.S. Department of Labor has issued rules that could affect your 401(k) plan. These rules spell out what steps a “participant-directed” plan must take for plan fiduciaries — including employers — to avoid liability for poor investment decisions made by plan participants. Generally, these rules require at least three core investment options and quarterly investment switching. Make sure that any plan you’re considering meets these rules.
THIRD, LOOK CAREFULLY AT THE ADMINISTRATIVE CAPABILITIES OF THE SERVICE PROVIDER. Some providers seek to offer superior investment returns or broad investment flexibility, but are lacking in administrative ability. Remember: Administration is one of the most critical elements of a well-run 401(k) plan.
Check around to gauge the provider’s reputation for plan administration. Call some of the local customers of the provider. Ask, for example, if they’ve received late or incorrect statements. If so, find out how the provider handled the problem. Make sure that any problems were handled quickly and accurately.
FINALLY, FIND OUT WHETHER THE SERVICE PROVIDER HELPS YOU WITH ONGOING EMPLOYEE COMMUNICATIONS. Communicating the plan’s features and benefits is essential to broad participation. And broad participation is essential to a successful 401(k) plan.
Most service providers will meet with employees when the plan is first set up to help “sell” the plan to them. Often, though, explaining the plan to new employees is left to you. A service provider should be available to come in periodically to reinforce the value of plan participation to employees.