Optimizing Your 401(k) Plan
As time has passed, ostensibly your business has adopted new projects, pivoted strategies based on outlook, or focused on a specific client sector in light of new and developing information. Internally, your business may have undergone structural or operational changes to accommodate these procedures or emphases on specific revenue sources. As it relates to your 401(k) plan, parallels can be drawn to these changing landscapes that many businesses experience throughout time. A number of separate variables contribute to the current state or “health” of a given 401(k) plan, and while the overarching goal is to optimize a plan throughout each of these facets, a plan must first be brought up to speed with respect to current compliance benchmarks and regulations. While we can assume the people at the IRS are compassionate and neighborly, it is most likely best to keep these conceptions about the department intact by never experiencing a visit from them firsthand.
There are many variables that contribute to the health of a 401(k) plan, but a few fundamental principles are as follows:
Participation rate - meeting top-heavy plan rules
Participant contribution
Employer contribution
Sufficient fidelity bond
Rate of return on investments
Participation Rate, simply the number of active participants versus the total number of eligible employees, is a highly important variable as high participation mitigates the risk of a top-heavy plan. A plan is considered top-heavy when employees considered to be highly compensated own an outsized percentage of the plan’s total assets. The threshold for a top-heavy plan is when “the aggregate value of the plan accounts of key employees exceeds 60% of the aggregate value of the plan accounts of all employees under the plan”.[1] In some cases, when a plan is top heavy, employees contributing the IRS maximum may not be able to do so, and corrective distributions may be made. A corrective distribution returns plan contributions that a highly compensated employee has made back to the employee, thus bringing their total contribution to below the IRS maximum.
Participant Contribution, another important factor, often measured between year-over-year contributions from employees can reveal employee satisfaction with the plan. If contribution percentages from employees are decreasing on a year-over-year basis, this may indicate that employees are not seeing the benefits of the plan, or saving and investing for the long term through the 401(k) has lost priority in their financial framework.
Employer Contribution is also worth considering. Industry standards for employer match percentages may have changed since the plan was set in place, which may be causing top candidates an employer is looking to hire to decide to work elsewhere. A top employee prospect could potentially decide where they choose to work based on the contribution match percentages of the employer.
Sufficient Fidelity Bond, if the plan has grown through time, the fidelity bond may not be sufficient. The bond amount must be 10% of the total plan or $1,000, whichever is greater. An ERISA fidelity bond is a “type of insurance that protects a 401(k) plan from losses caused by acts of fraud or dishonesty (e.g., theft, embezzlement or forgery) by plan officials”. A plan official is any person at a company who “handles plan funds or other property” or any person who has the ability to transfer plan money, sign checks, or “negotiate plan property (e.g. mortgages, title to land and buildings or securities)”. [2]
Rate of Return on Investments. This facet of a plan is of course important so that employees contributing to the plan are in the best-perceived allocation in accordance to their risk tolerance and time horizon. It is imperative to ensure that an employee’s allocation is properly diversified between sectors & geographies in the equity and bond markets. As the adage goes, past performance is no guarantee of future results, but history has demonstrated the benefits of diversification. In a study conducted by JP Morgan Asset Management between 2001 and through 2020, a diversified portfolio outperformed a less diversified portfolio. The study backtested model portfolios against major global indices, and the less diversified portfolio, consisting of the S&P 500, EAFE equities, and Bloomberg Barclays Aggregate returned 6.6%. A more diversified portfolio, which also included emerging market equities, small cap US stocks, among other diversified exposure returned 7%, and was less volatile. [3]
Fund costs are another notable aspect to consider when developing an allocation; if a plan has not been reviewed in some time, there may be an opening to fee reduction for options in the plan.
Overall, our life expectancy continues to increase, and data shows that many may need to anticipate living in retirement for more than 30 years, which in turn for many may translate to a shift in investment allocation revamp time horizons. Increasing employee participation in the present has the ability to benefit us in the long run as we will likely have only a limited ability to rely on Social Security to supplement wages in retirement. Outside of merely complying with current IRS regulations, a proactive employer has the ability to encourage retirement contributions from his or her employees through an optimized and up-to-date 401(k) plan that could attract better hires, contribute towards employee satisfaction, and benefit employees in the long run at their time of retirement.
Disclosures & Sources:
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often neutered for investments in emerging markets. Asset allocation does not ensure a profit or protect against a loss.
Investing in mutual funds involves risk, including possible loss of principal. Find value will fluctuate with market conditions and it may not achieve its investment objective.
Stock investing includes risks, including fluctuating prices and loss of principal. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect principal.
The economic forecasts set forth in this material may not em develop as predicted and there can be no guarantee that strategies promoted will be successful.
The Financial Consultants at Vintage Wealth Advisors are registered representatives with, and securities offered through, LPL Financial, Member FINRA/SIPC. Investment advice and financial planning offered through Financial Advocates Investment Management, DBA Vintage Wealth Advisors, a registered investment advisor. Financial Advocates Investment Management, Vintage Wealth Advisors, and LPL Financial are separate entities.
Employee Fiduciary - 401(k) Fidelity Bonds - Frequently Asked Questions
JP Morgan Asset Management, 2021 Guide to Retirement, JP Morgan Distribution Services, Inc. Copyright JP Morgan Chase &
Co.