When it comes to building wealth on a tax-deferred basis, the benefits of a 401(k) plan are too good to pass up.
If your company doesn’t have a 401(k) plan, now is a good time to start one. If you already have a plan in place, there are ways to improve it and protect yourself from unpleasant surprises. Here are eight tips for success:
1. Don’t put all your eggs in the safest basket. Some CEOs think the best way to comply with federal rules is to place all the 401(k) money in guaranteed vehicles, such as certificates of deposit or Treasury Bills. But inflation erodes the value of these fixed-income vehicles. And by only holding the safest investments, you may violate Department of Labor suitability and diversification rules.
2. Formally document the plan’s goals. Have an “Investment Policy Statement” that describes performance standards and realistic goals for the money manager. If the Department of Labor audits your plan, regulators scrutinize the decision-making process more closely than the actual performance. All your mutual funds don’t have to be performing in the top 25% but you do have to show that you’re being prudent.
3. Make sure paperwork is filed on time. This doesn’t have to be cumbersome if you get professional help. Make sure you file reports on time and maintain documentation to show you have a defined process for selecting and monitoring investments. Some small companies set up committees of two or three people to oversee the investments using rating services, such as Lipper and Morningstar. The committees then prepare memos about the evaluations for the company files.
4. Educate staff to magnify your benefits. Federal 401(k) rules reward company owners — presumably the best-paid employees — for encouraging lower-paid employees to participate. It works this way: The most an employee can contribute to a 401(k) account is usually about 20% of compensation. If lower-level staff members sock away only 10% of their salaries, then higher-paid employees are limited to about the same 10%. Make sure your workforce is aware of the 401(k) tax breaks and the ability to borrow against assets to pay for college tuition or the down payment on a house. A low percentage of participation may indicate you aren’t providing enough educational materials.
5. Consider automatic enrollment to boost participation. Some company 401(k) plans now have a feature that automatically enrolls employees when they become eligible without requiring them to submit a request to join. Under this option, a predetermined percentage of employees’ pay (generally 3%) is deferred as soon as they become eligible for the plan. If they don’t want to participate, they must request to be excluded by filing a form, calling a phone number or going to an online address.
6. Remember, you can be personally liable for violations. If you run afoul of the law, it’s not just the corporation that can suffer. CEOs and other executives who are made trustees can be held personally responsible for violations.
7. Build your own nest egg (and employees) by contributing to employees’ accounts. By having the company “match” 25 cents, 50 cents or even a dollar for every dollar that employees put into their 401(k) plans, you can increase your own tax-deferred growth. Plus, matching contributions can help recruit, retain and reward good employees. In 2017, the maximum amount of salary that you can set aside in a 401(k) plan tax-deferred is $18,000, or $24,000 if you are 50 or older (unchanged from 2016).
8. Hire a knowledgeable adviser. To avoid compliance problems with federal regulations, make sure your plan is reviewed by a professional who is knowledgeable about the Employee Retirement Income Security Act (ERISA). Relying on a generalist adviser may not be enough.