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9 Best Practices

Making the most of your 401(k) program

You know there are affordable, simplified 401(k) plans for your business, even if you're self-employed. You see the unique benefits 401(k)s offer in terms of savings and tax advantages, and that a 401(k) makes a strong recruiting and retention tool.

If you have employees, your question now may be, "How do I design a program that can be successful for my business?"

Keep your program simple to be effective

There can seem to be a million choices when you set up your 401(k) plan. We recommend keeping it simple to meet your savings and business goals. Adopt the nine best practices on this page to use your 401(k) plan to its fullest.

1. Sell the plan

Promote full participation in your company's 401(k) plan and endorse your plan benefits. Make certain your 401(k) is a cornerstone of your annual benefits review.

Why: Getting the word out on your 401(k) program makes it easy for your employees to get involved. It's a great way to help make a difference in their lives and create greater loyalty to helping grow your business.

Key items to tell your team:

  • A 401(k) helps employees save for retirement while reducing taxes.
  • (If you opt to provide a match) Participating is like receiving a bonus!
  • Sooner is better than later: employees who start younger are more likely to have a greater nest egg at retirement.
  • Know your provider's toll-free number for customer support, and a web address for online resources.

2. Achieve high enrollment

Build in "auto-enrollment," which automatically enters each employee into the plan. (They can opt out.) Make it a goal to achieve over 90% participation with a default contribution of 3% gross pay.

Why: Automated enrollment is a simple way to make sure most of your people are saving for tomorrow. And high 401(k) participation helps drive employee loyalty and retention, saving you valuable time and money.

More facts: Most employees – 69% in one study – would prefer to be auto-enrolled.1 The average 401(k) participation rate is only 66%, but when auto-enrollment is established, participation jumps to 92%.2

3. Provide a company match

If you can afford to match, then by all means do so. Matching for the first 3%–6% of employees' contributions is recommended. Or consider annual profit-sharing contributions as an alternative.

Why: A match is a great incentive for employees to get involved, and is almost always tax-deductible for your business. Of course it helps increase savings, plus it makes your company's program competitive with bigger businesses.

4. Allow immediate eligibility with short vesting

Get employees started right away in their plan and give them true ownership of their investment dollars.

Why: A 2- to 3-year vesting schedule ensures you're not spending company dollars on "short-timers" while still providing a nice incentive for employees to stay with your company. Vesting schedules of 4 or more years are not as compelling for your employees.

5. Offer low-expense, market-efficient investments

Select diversified investments with low expense ratios — exchange-traded funds (ETFs), which track the major indexes and are diversified and efficient by their very nature.

Why: First, costs can be a serious drag on returns over time, so offering index funds makes sense. Second, the "efficient market hypothesis" suggests it's very tough for investors to beat the market.3 If you can't beat it, join it! (But keep company stock out of the plan to avoid conflicts of interest.)

More facts: To learn more, we suggest reading "A Random Walk Down Wall Street" by Burton G. Malkiel.

6. Keep investment choices simple

Limit the number of investment options to 15 or fewer, while maintaining plenty of diversification.

Why: Too many choices tend to overwhelm employees. Offering a lot of investment options lowers the likelihood of employees participating in your plan.4 It also makes it more difficult for participants to make good decisions on which investments to select and the percentage to contribute to each.

More facts: In one study, 401(k) participation rates were 70% with 12 investment options, but fell steadily to 60% as choices were increased to 60 options.

7. Plan for increases

Install a program which automatically boosts each employee's deferral when his or her salary rises. A 1% increase in your employee's contribution to his or her 401(k) account is the standard recommendation.

Why: This strategy helps employees contribute more as they earn more. Participants tend to like automatic savings adjustments that align with their raises, as they see no reduction in takehome pay.

8. Discourage early withdrawals

Reduce employees' temptation to borrow and spend their retirement savings by restricting 401(k) loans to hardship cases only.

Why: It's good to have access to 401(k) funds in a true emergency, but withdrawals hurt savings' growth over time. And if an employee leaves the company, the 401(k) loan repayment is due immediately or a tax penalty will apply. That can really put a dent in a nest egg!

9. Automate IRA rollover

Build in an automatic IRA rollover to ensure that departing employees have their funds for tomorrow. Advise strongly against "cashing in" their 401(k) plans when changing employers.

Why: An automated rollover helps your employees secure retirement savings in a tax-advantaged IRA and avoid losing the money to taxes, penalties, or a spontaneous spending spree. 401(k) funds withdrawn before the age of 59½ are subject to taxes plus an additional 10% penalty. Ouch!

9 great steps to a 401(k) program you can be proud of

Offering a cost-effective, hard-working 401(k) plan as part of your company's benefits package can make a real difference in your employees' futures – and that of your business as well. Keeping the program simple and as automatic as possible enables everyone to be more involved and makes it easy on you.

Whether you're just getting started or looking to get your current plan under control, there is no better time to optimize your 401(k) program. We think you'll start seeing a difference in productivity and job satisfaction immediately. And as for the benefits down the road, well — let's just say the best is yet to come!

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