The Case for a Micro 401(k)
By Joseph Regenstein IV, CMFC
The Need to Attract and Retain Employees
According to the Employee Benefit Research Institute defined contribution plans have increased steadily from 25.8% in 1988 1. In 2006 67.1% of all employer sponsored plans are defined contribution plans such as 401(k)'s. Popularity of these types of plans are largely due to shifting investment risk from the employer to the employee. Employers have increasing been the providers of retirement plans for employees and this has created a dilemma for many small businesses. Businesses often compete with larger rivals for employees, not having a plan might make it difficult to attract or retain quality employees. However, the fixed costs of administrating a plan weigh heavier on the small employer, for instance a $1,500 annual fee breaks down to $150 per employee. A larger firm with 100 employees may have a lower per employee cost of $15, making the expenditure a more attractive employee benefit. In addition, the investment provider and third party administrator might discount the administrative costs based on the assets in the plan, another advantage for larger employers.
The Need to Reduce Costs
Business of all shapes and sizes are looking for ways to boost the bottom line, finding cost savings is currently at a premium. We have seen a wave of employers migrating away from plans purchased through a payroll and transferring them to a micro 401(k) provider. At Rainstone Financial we recently reviewed one of our Small Business Client’s qualified retirement plans and recommended they make a change to their 401(k). The Client has 8 employees and participates in a 401(k) through Paychex with a monthly administrative cost of $125. After reviewing the employer’s needs it was determined a micro 401(k) with a total administrative cost of $250 annually was more appropriate2. This continues to provide the employer with all the same features as the payroll provided plans with a reduced cost. It is important to ensure the new plan has adequate investment options, flexible plan design and is easy for the employer to submit contributions.
The Micro 401(k) Solution
Flexible Plan Design
Micro 401(k) plans offer small business a flexible way to invest for their retirement and allow retirement savings for their employees through:
Discretionary salary deferral contributions. Salary deferral catch-up contributions (individuals aged 50 or over). Safe Harbor matching contributions.
The flexible nature of micro 401(k) plans allows business owners to start, stop or later alter their salary deferral. The Safe Harbor matching contributions plan design eliminates otherwise standard non-discrimination testing requirements (provided all requirements are satisfied).
Flexible Distribution Options
Subject to certain distribution requirements, business owners and their employees have access to their 401(k) account based on certain common distribution triggers. Distributions are generally available upon:
Reaching age 59½ Separation from service Death Total disability Termination of the plan A qualified financial hardship
The plan document will define the options for each 401(k) plan. Distributions are subject to ordinary income taxes and could also be subject to a 10% penalty if made before reaching 59½.
Loans
Loans may be permitted from a micro 401(k) plan if allowed by the plan sponsor subject to certain limitations.
Consolidation
New tax laws now make it possible for plan participants to consolidate all of their retirement accounts by rolling over or transferring their assets in their 401(k) account.
Safe Harbor Design Eases Administration
Since micro 401(k) plans are geared toward very small business, they elect to use a Safe Harbor design to avoid complex and sometimes costly testing requirements. Administration services are offered through micro 401(k) providers or third party administrators.
Who may be a likely candidate for a micro 401(k)?
1. Small Businesses with 10 employees or less. 2. Business owners looking for a plan that offers higher salary deferral contribution limits over Traditional , SEP and SIMPLE IRAs3. 3. Small business owners who previously declined 401(k) setup due to administrative cost concerns. 4. Businesses with employees who desire to defer for their retirement savings.
Who may not be a likely candidate for a micro 401(k)?
1. Small Business with more than 10 employees. 2. Businesses that have contributed to a SIMPLE IRA already in 2009 or have had the SIMPLE IRA for less than two years 4. 3. Small Business where the only employees are owners or owners’ spouses, a Solo-401(k) may be more appropriate4 .
Citation
1
Employee Benefit Research Institute. Retirement Plan Participation: Survey of Income and Program Participation (SIPP) Data, 2006. February 2009, Vol. 30, No. 2: pp 16.
2
Hartford Emerging Business Platform with Dyatech EB Plan Link as the Third Party Administrator.
3
U.S. Department of Labor's Employee Benefits Security Administration (EBSA) and the Internal Revenue Service. Choosing a Retirement Solution for Your Small Business. Washington D.C.: 2007.
4
Department of the Treasury and the Internal Revenue Service. Publication 560: Retirement Plans for Small Business (Sep, SIMPLE and Qualified Plans). January 15 2009, pp 21. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete Joseph Regenstein IV, a Financial Planner, offers advisory services through Jonathan Roberts Advisory Group, Inc. He offers securities through J.W. Cole Financial, Inc. Member FINRA/SIPC. To contact email jregenstein@rainstonefinancial.com, call Rainstone Financial at 407-412-7028 or mail to 3731 Safflower Terrace, Oviedo, FL 32766