The government has sent the message that you're responsible for your own retirement,” says Brad Williams, Insurance & Consulting Associates, Kansas City, Mo.
Depending on an individual’s age, he or she may reap some of the benefits of Social Security, but at best it will provide supplemental income. This is where you as an employer can step in to help your employees better prepare for retirement. Whether retirement is five years or 35 years away, it's wise to map out a retirement strategy to ensure a comfortable living in line with inflation during those years.
Of course, the earlier your employees start preparing, the better. There are a lot of options, but one of the more popular ones is a 401(k) plan. Put simply, it's a savings plan that allows an employee to contribute pre-tax dollars through a payroll deduction. The earliest an individual can access the money without tax penalties is age 59 1/2. He starts paying federal taxes when he begins withdrawing the money. Unlike traditional pension plans, a 401(k) plan lets your employees choose their own investment options from those that you offer. These investment earnings continue to grow tax-deferred, and as Williams points out, the annual contribution limits are significantly higher than the traditional Individual Retirement Account maximum of $2,000 a year. As of Jan. 1, 2000, the total annual 401(k) tax-deferral limit is $10,500, which is $500 higher than last year. As an employer you should offer a variety of investment options, with a good mixture of both stocks and bonds available. The accompanying chart to the right shows how much money an individual can earn by saving just $100 a month.
“We’re seeing the 401(k) as the second highest employee benefit behind group health insurance,” says Williams.
For employees, there are definite advantages of participating in a 401(k) plan:
- You make contributions through payroll deductions.
- You design and control your own investments.
- Tax Savings
- Contributions are exempt from federal and state income taxes.
- Earnings grow on a tax-deferred basis.
- Some employers contribute additional funds to employee 401(k) accounts. However, these funds may be subject to a vesting schedule, which means the employees will have to work a specified number of years to receive the employer’s “matched” funds. Sometimes a company will pay a percentage of those funds if an employee leaves a job before he is fully vested.
- Employee contributions are 100 percent immediate vested, which means all the money an employee puts in is his regardless of how long he stays with your operation.
- Withdrawal and loan provisions
- If this provision is available, employees can use plan assets for college expenses, home purchase and other financial needs. However, an individual will be taxed on any money he takes out.
- Self control of retirement savings
Not only does a 401(k) offer your employees advantages, but you can benefit as well. Just ask Gloria Hanson, human resources officer, D&D Farms, Pierre, S.D. “Our industry is no different than any other. Low unemployment has affected the labor pool. Benefits are important to perspective employees; it's the first thing they ask about – health insurance and retirement plans.”
As an employer you also can benefit by offering employees a 401(k) program:
- Employer contributions are tax deductible and earnings are tax deferred.
- Offering a 401(k) program builds morale and can attract job candidates.
- Employees share in the cost of saving for their own retirement.
- Flexible schedule
You have the ability to set up a 401(k) program that fits your needs and those of your employees. You can choose the investment options you offer. For example:
- How much, if any, type of matching contribution you will make;
- When employees become eligible to enroll in the plan;
- How many years it will take employees to become fully or partially vested;
- Whether you will allow employees to take a loan from their 401(k).
“Part of our management philosophy is determining what we owe our employees,” says Hanson. “We take the approach that there are three major financial events in a person’s life: buying a house; your children’s education; and retirement. Then we talk about ways to help our employees afford those things.”
Hanson says about 70 percent of the eligible employees are currently enrolled in D&D Farms 401(k) program. Plus, there's an opportunity for tax-free savings for those not enrolled.
“When we pay someone a bonus, it’s company policy that half of it automatically goes into a 401(k) and the other half goes into his or her paycheck,” Hanson notes. “That’s the case even if the person is not participating in a 401(k) plan.” That’s because D&D Farms is committed to retirement plans.
Williams believes for a 401(k) program to be truly effective, there has to be an employer match program. “A good idea is 25 percent up to the first 6 percent that the employee defers,” he says.
Overall, 401(k) plans are fairly standard in all types of businesses. But, anyone with fewer than 100 employees, can use the Safe Harbor options. A significant benefit of this version is that employees are immediately fully vested, instead of having to use a vesting schedule.
Vesting schedules make employees wait one year to enter the retirement program and may offer full vesting after five or seven years of service with the company. While vesting schedules provide you some security as an employer, they can discourage job candidates.
The Safe Harbor plan also requires you to choose one of three contribution schedules. The other significant differences deal with the average deferral percentage, average contribution percentage and annual additions to an employee’s account. (See table on page 36). These key tests prevent the plan from discriminating against highly paid employees – those making $80,000 or more annually. The plan allows those employees to contribute no more than 2 percent of their annual income.
In addition, there’s an Automatic Enrollment Rule where new employees are automatically enrolled in the company’s 401(k) plan. Williams says this option is used in about 7 percent of all plans. It lets employers automatically defer 3 percent of an employee’s salary and invest it in a balanced stock/bond account. If you offer this, you will need to inform job recruits up front, letting them know that they can decline automatic enrollment by signing the appropriate documents.
Bottom line, if you’re an employer a 401(k) program may be the best selling point you have when it comes to hiring and keeping employees. If you’re an employee and you have a chance to enroll in a 401(k) plan, do it. It could be the wisest long-term decision you make.