In Part I of this series, we covered safe harbor plans, which eliminate corrective distributions. This part will offer some ideas that don’t have that same guarantee, but they have proven to reduce or even prevent them over time. Safe harbor requires some fairly significant employer contributions in return for the exemption from testing while these options have more flexibility with match dollars. Just like every decision you make in business, there are tradeoffs. It is definitely a best practice for fiduciaries to take the time to weigh out these options if your plan is in this situation.
If you have low participation in your plan, which is often the cause of corrective distributions, automatic enrollment could be a viable solution. The natural response to that statement would be that if they wanted to participate, they would. Most employers are reluctant to do automatic enrollment because they fear a line of employees outside the HR office door to opt out. The reality is that some employees just need that boost to participate. Sure, some will opt out. However, there are studies that show that close to 60 percent of defined contribution plans are now using auto enrollment. Furthermore, almost three quarters of those plans automatically increase those deferral rates annually. That is called auto escalation. Automatic enrollment is rapidly gaining in popularity. It is worth the time to evaluate it and maybe even poll some employees to see what they think if you are skeptical. You may be surprised by the results.
Another major cause of corrective distributions is employees participating at low deferral rates. If your plan has 90% participation, but the average participation rate is 2%, then you are likely to have a problem. Stretching out your match incentivizes employees to participate at higher rates. For example, let’s say your plan has 100% match up to 2%. You can stretch the match out to 50% up to 2% or even 25% up to 8%. It is still costing you the same amount in match dollars, but the employees need to participate at higher rates to receive the full match. Overall, this does more than reduce corrective distributions. It motivates your employees to save more, which will ultimately lead to better outcomes for them in the long run.
This is the simplest solution. Is anyone promoting the plan to the employees and encouraging them to participate? When is the last time you had an education meeting for the employees? It is up to you and the professionals that you hire to make sure that the employees are aware of the plan and the benefits to them over the long term. Repetition is key. Many employees leave an enrollment meeting or read an e-mail with full intentions of enrolling in the plan. Life takes over and they don’t enroll. It is critical to have that next meeting or send that next e-mail to keep it in front of them.
If you have gone through the effort to offer a 401(k) plan to your employees, you should make sure that it is the best it can be for both you and them. Corrective distributions are a sign that your plan has room for improvement. We strongly encourage you to lean on your plan professionals to come up with a strategy to reduce these distributions. Less money coming out of the plan means more money compounding in the plan for the long term.