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Article added or updated:
03/30/2008 |
Entrepreneurs Should Like The New Pension Law-
Pension Protection Act of 2006
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Author:Karen Sanchez
Even as
401(k)  plans have exploded in popularity, many studies have
found that workers are not enrolling in them, not contributing enough to
them and generally failing to choose the appropriate investments.
Indeed, it is astonishing how many employees fail to enroll in defined
contribution plans despite repeated cries from employers and financial
experts.
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Now, the Pension Protection Act of 2006, recently signed into
law, promises to turn the tide. The PPA is the first significant piece
of legislation that offers incentives and protections that encourage
small businesses to embrace automatic enrollment in
401(k) plans to get
more people saving--even if they are too lazy or disinterested to do it
on their own.
Why should entrepreneurs care about the new law? It's no secret that
helping employees save for retirement leads to a happier, more
productive and increasingly loyal workforce. (At last count, some 6
million workers at companies with less than 100 employees invested in a
401(k) .) And owners that encourage saving by offering to match employee
contributions enjoy tax deductions (15% to 40%, depending on how much
the company earns) on their own company contributions.
The Benefits Of Automatic Enrollment
One way to get employees involved has been to automatically enroll them
in the plan. The employer simply plucks a certain percentage of an
employee's salary and sticks it in the plan. (Before they do this,
employers must first fire off a notice detailing the plan, the
percentage contribution and a statement that says the employee can
cancel participation at any time.) In most plans, the standard default
contribution is set at zero percent of the employee’s salary; automatic
enrollment raises the default, typically to 3% of the employee's pay.
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enrollment also addresses a common gripe among highly compensated
employees in small companies--namely, that they aren't allowed to make
large enough contributions to their retirement plans. That's because
their participation rates are tied to the participation rates of the
other employees. The more employees that participate in the
401(k) plan,
the greater the amount of earnings higher-paid employees get to sock
away.
Yet for all its advantages, automatic enrollment has raised all sorts of
legal issues. Some state wage-and-hour laws guard against employers who
pull money out of employees' paychecks. (Simply sending out that
notification doesn't cut it.) Result: Small businesses have been
reluctant to use automatic enrollment for fear of getting sued.
A New Era
Enter the PPA. The new law offers employers protection from state
payroll-withholding laws to allow for automatic enrollment. Essentially,
it is now legal to automatically enroll employees and increase their
contributions without their approval. (They can choose, within 90 days,
to opt out and get back any automatic contributions without paying a
penalty.) Better yet, the PPA offers employers more protection--though
not complete immunity--from legal action taken by employees who feel
they were led astray by the plan's financial adviser.
The PPA also includes automatic-enrollment "safe harbor" provisions
related to certain contribution rules. In other words, it gives you an
additional pass on that participation-rate problem, allowing well-paid
employees to max out their contributions with virtual impunity,
regardless of how much other employees choose to save.
As for default contributions, the rate for automatic enrollees must be
at least 3% during the first year of participation, 4% during the
second, 5% during the third and 6% thereafter. The employer, meanwhile,
is required to provide a maximum contribution of 3.5% if an employee
contributes 6% or more of compensation; under the traditional safe
harbor formula, the employer contributed a maximum 4% if an employee
contributes 5% or more.
Model Portfolios
The typical
401(k) plan offers approximately 15 mutual fund investment
choices, and participants must choose how much to invest in each fund.
Plans that offer a larger number of funds tend to confuse participants;
indeed, surveys have shown that participants often select fewer funds in
a plan with more options.
The most effective solution is to provide preset allocation models
assembled from the list of available mutual funds in the
401(k) . Model
portfolios allow the participants to put their account on autopilot and
not worry about making changes to their fund allocations. The models are
periodically rebalanced and cover the spectrum of investors, from
conservative to aggressive. The approach is similar to increasingly
popular "lifecycle" funds, but typically come without another annoying
layer of fees.
With the incentives provided by the PPA, small businesses should not shy
away from adopting automatic enrollment. It will go a long way toward
building and maintaining a more productive and loyal workforce.
Karen S. Sanchez, CPA, QPA, is director of
employee benefits services at Sikich LLP, a professional services firm
in Aurora, Ill. For more about Sikich, check out
www.sikich.com. |
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prior to acting on any advice found here. We do NOT dispense advice on
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