Business owners agree that having a robust benefits package is critical to attracting and retaining top talent. Included in that package is a retirement plan, typically a 401(k) plan, with some type of employer contribution to give employee savings a boost. But what happens when employees aren’t taking care of their end of the bargain and using that plan to its fullest? In many plans, owners end up getting all or a portion of their retirement contributions refunded each year. While a refund doesn’t necessarily mean something terrible happened, it’s certainly frustrating for business owners who also wish to retire. There are a variety of plan designs to help prevent this from happening. Let’s look at a sample case.
- 1 Business Owner – Wishes to Max Out Deferrals/Contributions
- Business Owner’s Spouse – Wishes to Max Out Deferrals/Contributions
- 33 Employees
- 401(k) Plan in place with around $2,500,000.00 in the plan
- Goal of the 401(k) is to allow owners to save while providing a savings tool to retain and attract top talent in their industry
Deferral Only Plan Study 1: Business Owner and spouse contribute $26,000 (max) to the plan. Other employees generate an average savings of around 2%. Some are at 0% and some were told that 3% was a great starting point but never changed amounts as careers progressed. Since both owners are maxing out contributions to the plan and all other employees are averaging 2%, this will likely result in a failed test, requiring refunds. Based on this example, a great chunk of the owner’s 401(k) deferrals and the spouse will also receive a refund leaving only a fraction of the intended contributions in the plan. Worse yet, if the owner and spouse have 60% or more the plan assets, the plan would be considered Top Heavy. The correction for this testing result would be to give the non-key employees (in this case, non-key employees would be all employees other than the business owner and spouse) an additional 3% contribution, which is known as a corrective contribution.
Match Plan 50% up to 6% Study 2: Same deferral rate for the two business owners but now employees are incentivized to reach for a 6% savings goal to maximize and take control of their own retirement savings. Savings rate for non-ownership employees goes to 5%. This would still yield a failing result however refund amounts would be reduced AND the likelihood of the corrective contribution (3% above) goes down as employees now have a higher percentage of the annual contributions to the plan, which generally results in a larger slice of the plan’s assets. Great step forward for this plan!
Safe Harbor Match Plan Study 3: In this example, the business would provide a match of 100% of the first 3% and 50% of the next 2%, Another way to think of it would be that if an eligible participant defers 5% of their salary into the plan, they would get 4% from the employer as a matching contribution. What works great here is that by using this plan design, the plan as a whole would not be required to perform the above annual tests from the previous 3 studies. That would effectively eliminate the refunds for the owner and spouse. Additionally, one of the perks of the safe harbor plan design is that the Top-Heavy test would be “deemed to pass” thus not putting the company at risk of the corrective contributions. If they did decide to put in a profit-sharing contribution on top of the safe harbor matching contribution, that could change which tests are required, but just by using this plan design now, the owners are able relax and not worry about the annual testing results and are able to maximize their retirement savings.
While the results of Plan Study 3 sound great, it’s not the right fit for all plans as every company is unique. If a plan sponsor wishes to provide profit sharing contributions on top of a standard contribution, there may be another path that makes more sense. Consequentially, employers with higher turnover rates may benefit from including a vesting schedule tied to the matching contributions. All of these factors, and more, play a role in deciding what plan design is best to achieving its purpose.
If you’re tired of 401(k) refunds, there are many ways to take back control of your plan and eliminate (or reduce) refund checks. At The Joseph Group, our RPS team has experience in plan design, as well as several trusted partners who can help solve retirement plan issues. We begin by offering a plan review that looks at Retirement Goals, Plan Efficiency, Plan Design and more. This review is offered at no cost and could help to eliminate those dreaded refund checks or other retirement plan issues. Please call me at the number below to discuss how The Joseph Group can serve you and your plan.
Written by Matt Kruckenberg, Manager of Retirement Plan Services. Matt can be reached at 614-907-8639 or firstname.lastname@example.org