A common 401(k) problem that many companies face on an annual basis is failing the nondiscrimination test, which results in highly compensated employees receiving unwanted refunds from their 401(k) contributions due to poor employee participation. From a big-picture standpoint, it should also come as no surprise that Americans are not currently saving enough to fund their retirement. In an attempt to increase participation and to pass the nondiscrimination test, many employers have added the automatic enrollment feature to their 401(k) plans.
The Pension Protection Act of 2006 allows employers to automatically enroll employees into 401(k) plans, requiring employees to opt-out if they do not want to participate. Companies that implement this feature must choose a “Qualified Default Investment Alternative” fund (QDIA) and the savings rate, which can also include an automatic escalation feature to increase contribution rates over time. Many studies have indicated that adding this feature to a plan does help to increase participation rates significantly.
There are many different options to consider when implementing these features, and for companies that are concerned with employees not saving enough for retirement and face yearly testing problems, now may be a good time to review their current plan design. Adding these features while continuing to provide employee education should certainly help companies maintain a successful 401(k) plan.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.