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The Importance of Offering a 401K Plan to Your Employees

By Elizabeth M. Rice, SPHR

In the past, employees were guaranteed a certain amount of income upon retirement through their company-sponsored pension plans. These days, pension plans are becoming obsolete and employees have to make it their responsibility to save or invest for retirement. To accommodate this shift in responsibility, as well as attract and retain good employees, more and more employers in the corporate world are offering 401(k) plans as part of their benefits package.

A 401k plan is a retirement plan sponsored by employers where employees can deduct a portion of their salary, pre-tax, and invest that deduction in a portfolio of investment options. Employers can choose to add extra value to the plan by matching or contributing to the employee's investment. For example, some companies may invest $.50 for every $1 that the employee invests.

To learn more about 401(k) plans, we interviewed Matthew D. Hutcheson, Certified Pension Consultant, Certified Retirement Counselor and an independent pension fiduciary. Hutcheson consults with sponsors of 401(k), pension and other types of retirement plans, and also serves as Trustee or co-trustee for many plans throughout the United States.

According to Hutcheson, there are three type different types of 401(k) plans that employers can offer allowing participants to make pre-tax contributions through payroll deductions:

• Traditional - In this most popular plan, employers have discretion to make contributions on behalf of all participants, to match employees' deferrals, or do both or neither.
• Safe harbor - In this option, employer contribution is mandatory. Employers' options include a matching contribution percentage for contributing participants or a non-elective contribution to all eligible employees. Under this provision, the employer contributions are always 100% vested.
• Full flex - This plan allows the employer to determine what kind of contributions they wish to make each year. Whether through profit sharing, matching or a fixed sum, the employer has flexibility on the amount, frequency and type of contributions that they make.

Hutcheson believes the employers should make 401(k) plans available, not only for the benefit of their employees but also for the greater good of our society. In his opinion, the 401(k) plan is more than an employee benefit, it's and economic security tool for their business and the economy. When employers equip their employees with the tools they need to retire in comfort, they are in turn creating employees with disposable income to spend in society and keep the economy in motion. Hutcheson gives the example of Henry Ford, who back in 1914, felt it was important to pay employees at least $5 a day, nearly double the wages offered by other manufacturers, so that each of them would be able to purchase a Ford.

Setting up a 401(k) plan is not difficult, but employers need to conduct due diligence to ensure they are getting a good plan for their employees. Hutcheson outlines some key factors employers should look at before selecting a 401(k) plan:

Look for simple plans. When the stock market was booming in the late 1990s, giving workers more investment choices was common. However, more options are not always better and as a rule of thumb, the more options you have the lower the returns will be. Eight to nine investment options are usually enough.

Don't look for 401(k) plans with loan clauses. Some 401(k) plans allow employees to take out money from their plan before retirement. These loans will erode your employees' savings and do not leave them enough during retirement

Look at costs. Almost all 401(k) plans are invested in mutual funds, and these mutual funds own, for example, individual stocks. These stocks need to be bought and sold over the course of the investment. Each time that this happens a brokerage cost is incurred. Find out if the assets are actively or passively managed. In an actively managed account the cost can be significant, averaging 2.27%. Passively managed accounts are usually tied to index funds and are very low. This cost is an addition to the fund management fee disclosed in the prospectus, and is also in addition to amounts that may be paid to a broker or investment advisor, so please choose your funds wisely, keeping all of the costs in mind.

Other costs that are typically hidden include general record keeping costs, including administrative items such as form submission, statement preparation and maintenance of accounts. Often times a 401(k) provider will claim there is no cost for these types of services, but this only means that the costs are hidden and funded through investments. Ask that your administration and investment costs be broken out to compare providers side by side and make sure you're getting a good deal.

Look for plans with pre-constructed investment portfolios. Your 401(k) service provider should provide pre-constructed portfolios for employees to chose from that include high-quality, low cost mutual funds.

Once the 401(k) plan is established, the next challenge will be to get employees educated about participating and investing. Companies should provide employees with an orientation and a general education on the plan that includes the individual plan beneficiary. Companies should also have a system in place for quickly notifying plan participants if any changes to the plan are made.

Employers should also consider taking proactive steps to help increase participation. One popular practice is to institute automatic enrollment whereby, upon eligibility, employees are automatically enrolled in the program at a set percentage amount. Automatic enrollment should be structured so that employees can choose to cancel their enrollment at any time. About 25% of large-company employers have put their plans on automatic, according to Hewitt Associates' 2006 survey of retirement trends. Another 23% said they were very likely to automate enrollment by the end of the year. Furthermore, employers can set an automatic feature to increase the employee contribution rate each year.

According to Hutcheson, 25-30% of retirees today are living at, or below, the poverty level. By taking the initiative and helping employees save for the future through 401(k) plans and other retirement savings programs, we can help reverse this trend so that everyone can retire and maintain their standard of living.