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
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
- 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
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
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
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
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!