Your company’s retirement plan can provide sizeable tax savings and greater employee retention. It may also represent a significant opportunity for you to reach deeper into the company’s pocket to save toward your own retirement.
This is the second of three monthly columns focusing on ways in which employer sponsored plans can be properly managed to maintain a happy employee base and maximize benefits for both you and your employees.
What’s the return policy?
From my last column, you may recall the problem of returned 401(k) plan contributions that upset a few of your employees.
Two employees, Dan and Helen, received some of their 401(k) plan savings back and the money will now be taxed as income because they were both qualified as “highly compensated employees,” or HCEs, after the plan failed its discrimination testing. The testing is required to ensure that a plan is benefiting all employees, not just executives, high earners or company owners.
Helen unfairly blames Dan, her sales manager, because she feels that he should have made her aware of this risk.
Why wasn’t she told about “discrimination testing” and the risk it might pose to her retirement savings? Wasn’t that Dan’s job, to communicate to his sales team?
Dan now notices the nasty side eye he gets from Helen on a daily basis and he stops by your office to discuss.
Helen has already stormed into your office twice today to complain that Dan is the reason she is getting money back from her 401(k) savings, so you aren’t surprised when Dan broaches the topic.
Dan asks you, “How do I keep my top sales people happy and increase their ability to maximize their 401(k) plan deferrals?”
“Safe harbor,” you tell Dan – without giving any further explanation, partly because you enjoy sounding cryptic, partly because you aren’t sure you can explain the concept.
Now hardly seems like the right time to mention to Dan that you, as a more than 5 percent owner and thus a “highly compensated employee” have received a sizeable chunk of your own 401(k) savings back too.
The fix: safe harbor
When annual discrimination testing finds that average contributions by HCEs exceed average contributions made by everyone else by more than 2 percent, that’s when some of your highest-paid employees – often your most consequential staff – might get an unexpected taxable distribution from their 401(k) plan savings.
You can avoid that by adopting a “safe harbor” provision, which allows for an automatic pass of the discrimination testing. It requires companies to make contributions to the plan at a specific level for all participating employees.
There are a variety of formulas – some rather confusing – that companies can use to determine what they should be contributing. The bottom line is that you will probably have to contribute anywhere from 3 percent to 4 percent of each employee’s pay.
The owner’s dilemma
You’ve managed to solve your plan problems using a safe harbor match formula, and now you and all employees, even the HCEs, can defer the full amount to their 401(k) plans without worrying about discrimination testing.
Now you’re ready to really sock some money away for your own retirement, but your $24,500 annual savings ($18,500 plus a $6,000 catch-up for being age 50 or older in 2018) plus the 4 percent match will hardly get you the amount of savings and tax benefit you’re going to need to get you to an early retirement.
In the next column we will review a couple of strategies to save even more into pre-tax company sponsored plans.
Registered Representative Securities offered through Cambridge Investment Research Inc., a broker/dealer, member FINRA/SIPC. Investment Advisor Representative Cambridge Investment Research Advisors Inc., a Registered Investment Advisor. Cambridge and Conte Wealth Advisors LLC are not affiliated.