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Look Out, Plan Refunds Are Coming!

Posted on Jan 13, 2012 by  in 401(k) Retirement Planning, Retirement Plans for Business

Typically a “refund” is thought of as a good thing – you’re going to get money back.  Unfortunately, when it comes to retirement savings, a refund from your 401(k) retirement plan is not such a good thing.  It means that you are not going to be able to save as much money for retirement as you had planned.  Also, you will not be able to defer income taxation on those savings and the associated earnings (your taxes will be higher as a result).
 

Are there 401(k) refunds ahead?

This time of year in our office, our staff of retirement plan compliance experts are busy conducting the complex nondiscrimination tests that are required for 401(k) retirement plans to determine whether the highly-compensated employees (business owners and high income earners) will be able to keep their 401(k) contributions in the retirement plan.  If the plan does not pass the nondiscrimination testing, some or all of the highly-compensated employees will probably need to receive a 401(k) refund by March 15.
 
While in some cases this result is very difficult to avoid, there are a few strategies that you can employ to help reduce the likelihood of refunds.
 
Educate
Simply put, the more money the non highly-compensated employees contribute, the more the highly compensated employees will be able to keep in the plan.  The one sure-fire way to increase contributions by employees is to effectively educate them on the importance of saving for retirement.  A good financial advisor can be invaluable when it comes to educating your employees about saving for retirement.
 
Design
In many cases a 401(k) retirement plan can be designed to increase participation, improve nondiscrimination testing, or even eliminate nondiscrimination entirely.  To increase participation, some strategies include offering a strategic employer matching contribution or including automatic enrollment provisions.  Sometimes a plan can be designed to use targeted employer qualified nonelective contributions (QNECs) or a top-paid group election to help pass the nondiscrimination test.  Finally, certain safe harbor plan features can be used to eliminate discrimination testing altogether.   An existing 401(k) plan cannot adopt safe-harbor features mid-year but it may be something to consider for your upcoming year.
 
Consult
Find a third-party administration firm that knows the intricacies of nondiscrimination testing for 401(k) plans.  Certain testing methods can be used to help achieve better results and reduce refunds.  Such testing methods include using “permissive disaggregation” or the “otherwise excludable rule” which allow the 401(k) plan to be split into several testing groups that are based on age and length of service of the employee.
 
Is your company doing everything that it can to minimize the likelihood of refunds?

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