| 5 Things Every 401(k) Plan
Should Have
 The
greatest lesson to be learnt from this economic downtown of 2009
is to save for a rainy day, have an emergency fund in case you lose
your job (just as millions of Americans are losing their jobs and
the unemployment rate claws close to 10%). As the stock market continues
to be very risky and volatile, a larger number of small business
owners are looking to set up 401(k) plans for themselves and their
employees, with there being 2 advantages to doing so; 1) they can
max out their 401(k) plans by contributing the maximum and receive
a larger tax deduction and 2) they can offer 401(k) plans to attract
and retain talented employees.
As well, many small business owners are
moving away from defined-benefit plans such as the social security
and pension plans, and setting up 401(k) plans because of the relatively
higher contribution limits.
For
example for the year 2009, a director making $100,000 a year
can contribute $16,500 (maximum 401k contribution limit for
2009) plus receive employer matched contribution of 6% x $100,000
= $6,000 making the total ($16,500 + $6,000 = $22,500). If
the director is 50 years or over, he can contribute an additional
$5,500 catch up contributions, bring the total to $22,500
+ $5,500 = $28,000. |
i) Low and More Visible Fee Structure
Starting in 2009, more and more scrutiny
is being done on the percentage of fees that are charged on 401(k)
plans and many companies are being criticized for the lack of supervision
in this area. Most small businesses charge 1% of total 401(k) value
for fees, however others charge upwards of 3-4%. You might think
what difference does a couple of percentage points make? It makes
a HUGE difference in the total nest egg! Here is an example derived
from Forbes.com.
Assume
you have $50,000 in a 401(k) and it returns you 8% a year
for 30 years with a 1% annual fee. Assuming you do not add
any money to your 401(k), you would have $372,168 in your
retirement account in 2039. With a 2% annual fee, your total
nest egg in 2039 is reduced to $274,451! That’s almost
a $100,000 difference, which is humongous! |
Before you shop for a 401(k) plan if your
employer already does not offer one, be sure to ask for the % of
fees upfront. The website you visit should give you a high level
idea of the total fees you should expect to pay, and do not be afraid
to look at multiple sources before deciding on the best one. Most
companies prefer to show fund expense ratios (the total fee measured
as a percentage of assets). Have a look at this number as well ask
for any hidden fees specified in the 401(k) prospectus.
ii) Large and Diversified menu of Investments
Your 401(k) plan should offer a diversified
set of investments across many different Indexes such as the S&P
500, the Dow Jones Industrials, Russell 2000 index, Dow Transports
or Utilities, as well as a healthy choice of ETFs and US Treasuries.
iii) Automatic 401(k) Enrolments
One of the biggest reasons why many employees
do not have 401(k) plans is the eligibility criteria as well as
the complication of filling out the forms, applying to a 401(k)
plan and meeting the eligibility requirements. Some small businesses
however have automatic enrolments, which is the best way to go.
Some companies will automatically enrol you in their 401(k) plans
unless you send a refusal letter in writing. This is known as automatic
enrolment and a percentage of your salary will be contributed to
the retirement plan in biweekly payroll deductions.
iv) 401(k) Employer Matching
The Internal Revenue Service (IRS) has
formulated a test that is conducted each year to make sure the owners
of the organization and the service level employees are both using
the 401(k) plans for contributions, and that there is no gaps left,
and the owners are not taking advantage of service level employees.
In order to satisfy this test by the IRS, most employers are looking
to make their 401(k) plans fair for both the highly compensated
employees such as the CEOs and VPs as well as low level employees
and managers. This is done via employer matched contributions.
Most employers prefer to contribute 50
cents on every $1 of contributions made by their employees. This
makes the 401(k) plan a fair one for both high level and low level
employees, and satisfies the IRS test. Also, an employer matched
contribution provides an instant return on investment (ROI). This
provides an incentive for employees to save for their retirement
which is exactly the whole purpose of 401(k) retirement plans.
v) Availability of Roth 401(k)
In traditional 401(k) plans, you make contributions
on a pre-tax basis. However in a Roth 401(k), income tax is deducted
from your total income and you make 401(k) contributions after having
paid taxes (this is also known as after-tax contributions). The
advantage to doing so is that you have already taken care of taxes
now, when you withdraw the funds when you become 65 years of age,
you will not have to pay taxes on it then.
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