As an employer offering a 401(k) plan to your employees, most of you should be finished with your annual non-discrimination testing by now.
What is this testing (in case you’re wondering)? For purposes of 401(k) annual testing, employees are classified as either a highly-compensated employee (HCE) or non-highly compensated employee (NHCE). In a typical 401(k) plan, NHCEs may defer up to the IRS maximums while HCEs are limited based on how much the NHCEs defer. The general rule is that the HCE group may only defer, on average, two percentage points more than the NHCE group average.
Some of you passed (congratulations!) and can now focus on other things.
A few of you may not have passed (condolences!), which can only be remedied by making a corrective employer contribution or by refunding enough highly compensated employees’ contributions to pass the testing.
As you may expect, the latter is by far the most popular option.
So what can be done to avoid having to take any corrective action? Why do some companies pass their testing and others don’t? Both good questions. There is something that can be done, but keep in mind that some companies still struggle passing their test every year—in particular, companies that have a young workforce residing in a city with a high-cost of living.
Bay Area employers, I’m sure this hits close to home.
But fear not: all companies, even those mentioned above, can implement measures to help pass this test.
So what do I need to do?
The key is to encourage participation in order to bridge the gap between the HCE and NHCE average.
If you were not able to pass the 401(k) non-discrimination test this year and would like to in the future, you have a few options:
You can match your employees’ contributions – As a general rule in life, if people are paid to do something, they will more likely do it. Employers can pay employees to contribute to a 401(k) through a company match, but of course, this can be costly. A typical match is 50% on the first 6% of compensation deferred, which can cost up to 3% of annual payroll. You could offer a smaller match, like 25% on the first 4%. This is an alternative that reduces the cost to 1% of annual payroll. There are also “Safe Harbor” contribution options that can waive most if not all annual nondiscrimination testing requirements, which is a safer, but costlier option.
Not yet ready to make a matching contribution at all? Well, let’s try. . .
Auto-enrollment – With this option, you can set each employee’s default election, typically 4% — 5%, shifting the onus of opting out or changing the contribution percentage onto the employee. Companies that don’t offer a match but have auto-enrollment have seen participation levels increase from the low 50% to the mid to high 80%.
Don’t feel comfortable preselecting a deferral amount for your employees? Well, let’s try. . .
Increasing employee awareness – Most employees know the benefits of contributing to a 401(k) (or will, after they read our earlier blog post), but it may not be on the forefront of their thinking, and after the initial excitement upon learning of its benefits, they forget all about it. To combat this, many companies offer annual or semi-annual employee education meetings. Some will offer periodic orientation meetings for new hires. Other companies recognize the need for personalized attention, so they offer 401(k) office hours with one-on-one meetings.
These are a few remedies to prevent failed testing and help improve your employees’ future financial security, all in one, or three, swoops. As an employer, the first step is to talk this all over with a 401(k) advisor.
And how fortuitous—I am one! Click on the “Let’s Talk” button at the top of the page to get a hold of me and my team.