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Maximizing Your 401(k): Avoiding Excess Contributions

October 03, 2012

By Joseph Potosky & Christopher Schaefer

As a business owner and plan sponsor, it’s in your best interest for your firm’s retirement plan to run as effectively as possible. A primary goal is to maximize the amount of tax favorable contributions into your plan. However, there are certain limitations on the amount you are allowed to defer. As defined by the IRS, the maximum amount of contributions you can make to a 401(k) plan is $17,000 per year as of 2012. (An additional “catch-up” amount of $5,500 can be deferred if you are 50 years or older.) However, poor levels of employee participation can result in excess contributions being returned to you, not allowing you to take advantage of the limits. If you receive money back or are unable to defer the maximum amount to your 401(k), this should signal that there is a problem with employee participation and utilization. It should prove imperative for you, as a business owner and plan sponsor, to increase the effectiveness of your 401(k), both for your employees’ benefit as well as your own. The following will outline a few measures that can be taken to increase participation, contributions and overall productivity of a firm’s retirement plan.

Safe-Harbor

“Safe-harbor” provisions can be taken to increase the amount of contributions that a highly compensated employee/employer makes. An employer can elect to make safe-harbor contributions. These are contributions with immediate vesting for employees of roughly 3-4 percent, allowing owners and key executives to defer the maximum - even if there continues to be low participation from employees. While safe-harbor provisions can eliminate the problem of excess contributions or low participation, it is important that one seeks professional guidance when opting to take this path. In many cases, the costs of a safe-harbor 401(k) outweigh the benefits for an employer.

Robust Education Programs for Employees

Providing an education program for employees can greatly increase participation and contribution rates. By coordinating with a plan’s advisor(s), employers can provide their employees with quality education from professionals who understand how to properly and effectively communicate the benefits of participating and/or contributing more to the plan. A robust education program will highlight key topics such as the importance of retirement planning in light of Social Security, the dangers that inflation poses to one’s financial security, the importance of saving early and the benefits of compound returns.  In addition, the program should highlight key investment strategies such as diversification, dollar cost averaging, and rebalancing. Also, by showing the quality of their strategies, advisors can help boost the confidence of inexperienced investors. A proper education program will also instill employees with a greater sense of urgency in regards to their financial security and future.

The Right Plan Administrator

A company’s plan administrator or HR professional proves to be instrumental in how much participation a plan encounters. Our experience shows that if a plan administrator is not resourceful, pro-active and enthusiastic in helping grow the plan, the plan will not thrive. Plan sponsors should be diligent in choosing a plan’s administrator. The sponsor should make sure to follow up with the administrator on a regular basis to evaluate the plan’s status and how the plan is moving forward. If a sponsor recognizes stagnation due to internal reasons, he/she should look to the plan’s administrator to see what steps can be taken to reinvigorate enthusiasm and contributions amongst the firm.

These are only some of the steps that can be taken to increase the potential of your 401(k). Many different avenues of success are available for plan sponsors. However, knowing which route will create the most successful results for your firm, with the least amount of pain, is important. Utilizing all the resources available to you will prove vital in ensuring that your plan prospers and grows.

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