As ACSI follows the annual results of surveys of employers regarding their “likes-and-dislikes” about 401k plans, we are seeing some very interesting trends. Many employers are telling a different story than what the lawmakers and regulators in Washington – the “Beltway” – have been saying.
For example, the SECURE Act that was passed in December 2019 included several notable retirement plan provisions. Among them was the approval of “pooled employer plans”, or PEPs. Under a PEP, multiple employers come together to offer a plan, typically a 401k plan, with the idea that “volume” – more employees and more contribution dollars – will make it easier and more cost-effective to maintain the plan. For several years, Congress, the IRS and the U.S. Department of Labor concentrated on approval of the PEP model. Prior to the SECURE Act, multiple-employer plans were legal in very limited circumstances.
Despite all the hype – and there has been a lot of hype – about PEPs being the solution for small employer 401k plans, employers indicate otherwise. We recently saw survey results reporting that 95% of employers with a plan are not at all interested in joining a PEP. Our own experience is that PEPs have been overhyped as a one-size-fits-all solution that is not the right solution for our clients who run small and medium businesses (SMBs). Also, the promise of cost-efficiency is not necessarily the reality. Given that there are many legal and technical issues that have not been addressed about PEPs, “building the plane as you fly it” is not what most SMBs want to do.
It is noteworthy that, based on IRS Form 5500 filings for the 2017 plan year, there were approximately 507,000 401k plans maintained by SMBs with fewer than 100 employees, out of the total of approximately 570,000 401k plans. These SMB 401k plans covered approximately 11 million plan participants.
There are many reasons why a SMB should seriously consider establishing its own 401k plan, if it has not done so. As the post-pandemic recovery continues, there are many reports that the increase in personal savings over the last year is at a record pace. Many employees want to save in 401k plans. For example, T. Rowe Price’s annual 401k plan benchmarking report disclosed that the average pre-tax 401k deferral rate for participants increased from 7.6% in 2019 to 7.8% in 2020, the largest annual increase since 2016. Those who continued to work during the pandemic and those who are returning to work list the availability of a 401k plan as one of the top priorities among employment perks.
Also, the personal tax-deductible contribution limit under a 401k plan — $19,500 or, if at least 50 years old, $26,000 this year – is much higher than the traditional IRA limit ($6,000 or $7,000) or the SIMPLE IRA limit ($13,500 or $16,500).
There are many different choices for features and options in a 401k plan. A SMB should not have a one-size-fits-all plan that is good for the provider but not ideal for the SMB. The SMB should determine its goals and objectives regarding the plan, and choose the right features for its circumstances.
Notably, those in the Beltway have made it more cost-effective for a SMB to start a 401k plan. One of the incentives included in the SECURE Act was an enhanced Federal Tax Credit for SMBs that establish a 401k plan. If the SMB qualifies, the Federal Tax Credit is equal to up to half of the “ordinary and necessary” start-up and administrative costs, i.e., out-of-pocket costs, for the new plan. The Tax Credit, which previously had been limited to $500 per year for three years, has been increased to a maximum of $5,000 per year for three years (determined by a formula, generally $250 a year for each eligible “non-highly compensated employee”).
The SECURE Act also included provisions encouraging employers to add automatic enrollment to a new or existing 401k plan. Automatic enrollment is a 401k plan feature whereby employees who do not voluntarily elect to contribute, or do not opt-out, will automatically have contributions deducted from pay at a predetermined rate. To encourage auto-enrollment, the SECURE Act added a Federal Tax Credit of $500 per year (for three years) for SMBs that adopt an automatic enrollment feature.
According to recent statistics published by Vanguard, 83% of employees contribute to 401k plans with automatic enrollment compared to 52% of employees in voluntary enrollment plans. Even more impressive is that 91% of new hires participate in auto-enrollment 401k plans versus 28% of new hires in voluntary enrollment plans.
ACSI is available to help you learn more about your 401k plan options.