Strategies for Retaining Top Talent in 401(k) Plans
As a seasoned 401(k) consultant with BGA 401k, I often find navigating retirement plan management like steering a ship through challenging waters. Particularly challenging is handling IRS compliance, where “corrective distributions” often present hurdles that can disrupt even the most adept plan sponsors. This blog aims to explain corrective distributions, discuss their effects on your crew of highly compensated employees (HCEs), provide strategies to minimize their occurrence, and ensure a smoother sail for your company’s retirement plan.
What Are Corrective Distributions?
Corrective distributions occur in 401(k) plans when the plan fails nondiscrimination tests mandated by the IRS. These tests include the Actual Deferral Percentage (ADP) and the Actual Contribution Percentage (ACP) tests. They are designed to ensure that the contributions made by HCEs aren’t disproportionately higher compared to those made by non-highly compensated employees (NHCEs).
Should a plan fail these tests, it essentially means that HCEs have saved more in their 401(k) plans, relative to their income, than NHCEs. The remedy involves returning some of these contributions to HCEs to rebalance the contribution scales. This not only affects the HCEs’ ability to save for retirement but also has tax implications, as these returned funds become taxable income in the year they are distributed. Many times, they end up having to refile their taxes – talk about getting seasick.
The Impact on Highly Compensated Employees
For HCEs, failing nondiscrimination tests and receiving corrective distributions can be a setback. It reduces their overall retirement contributions and subjects the returned amount to taxes that could have been deferred. Moreover, it disrupts the strategic financial planning undertaken by these employees for their retirement years.
Proactive Measures to Avoid Corrective Distributions
Working with a knowledgeable 401(k) consultant, plan sponsors can adopt several proactive strategies to ensure their plans pass the IRS’s nondiscrimination tests, thereby avoiding corrective distributions. Here are some effective strategies:
1. Plan Design Modification:
Consider redesigning the plan to include features such as automatic enrollment or safe harbor provisions. A safe harbor 401(k) plan automatically passes nondiscrimination tests if the employer makes sufficient contributions to employees’ accounts either through match or non-elective contributions.
2. Frequent Communication and Education:
Often, NHCEs under-participate in 401(k) plans due to a lack of understanding of the benefits or due to financial constraints. Enhancing employee education programs about the advantages of higher participation can increase overall contribution rates from NHCEs, balancing the scales naturally.
3. Contribution Rate Escalation Features:
Implement automatic contribution escalation to gradually increase employees’ annual contribution rates. This helps engage participants starting with low contributions by boosting their savings rate over time. Such incremental increases help maintain balanced contributions across all employees, enhancing compliance with nondiscrimination tests.
4. Use of Last Day Employment Requirement:
Incorporate a rule where year-end profit-sharing linked to 401(k) contributions are only made if the employee is still employed on the last day of the year. This can deter turnover and stabilize contributions metrics throughout the fiscal year.
Partnering for Success
Navigating the complexities of 401(k) plans can be daunting. As your 401(k) consultant, I am here to guide you through every step of the process. By collaborating with us, you gain a partner who not only helps you understand all aspects of your retirement plan but also strategizes with you to design a plan that meets both compliance standards and your financial goals. Our proactive measures ensure that your plan remains an effective tool for attracting and retaining top talent while securing their financial future.
Conclusion
Like a ship avoiding icebergs, corrective distributions are best avoided by addressing the underlying structural issues within a 401(k) plan. With proactive and strategic planning, corrective distributions can transform from a compliance headache into a strategic advantage. At BGA 401k, we are dedicated to partnering with you to optimize your retirement plan, ensuring it remains a steadfast ship capable of navigating the complex currents of retirement planning, attracting, and retaining the best crew while securing their financial futures.
Let’s discuss how we can optimize your 401(k) plan today. Together, we can build a robust framework that fosters growth, ensures compliance, and eliminates the need for corrective distributions, allowing your employees to focus on what matters most: their future.
Together, let’s Elevate the way we approach retirement plans.
Chris Cristallo, CFP ® , Qualified Retirement Plan Advisor
BGA 401k