Building A Better 401(K) – Part Two
A blog by Richard Rausser, CPC, QPA, QKA, Senior Vice President – October 11, 2014
In my last blog I discussed the benefits of the new Pentegra SmartPath™, a tool that offers a series of progressive plan design metrics crafted in a way to best ensure successful retirement outcomes for both companies and their participants. That post discussed the 401(k) plan’s automation features focused on in SmartPath™; here I will discuss some other boons.
The first of these involves adding a Roth 40(k) feature. Such an option combines the features of a traditional 401(k) with a Roth IRA, providing participants with a source of tax-free retirement income. The key differences between a traditional 401(k) contribution and a Roth 401(k)
contribution center on the tax status of both contributions and withdrawals, along with the rules governing rollovers.
Unlike a traditional 401(k) contribution, Roth 401(k) contributions are made on an after-tax basis. Traditional 401(k) contributions reduce a participant’s income for federal and (usually) state tax purposes at the time contributions are made and grow on a tax-deferred basis until the participant takes a distribution. Distributions are then treated as ordinary income. Roth 401(k) contributions and investment earnings, on the other hand, are tax free upon withdrawal as long as the participant has maintained the Roth 401(k) account for at least five years and has attained age 59 ½.
Of course, while taking a distribution from your Roth 401(k) is permitted, it is not a good idea. Many plans allow a loan once a year, and some participants – often younger employees, who still have not fully grasped the value of saving for retirement, many years in the future – do so annually, in effect viewing it as “free money.”
Nothing could be further from the truth, obviously. We encourage participants to think of such a practice as akin to a leaking bucket. The underlying concept of saving for retirement is to ensure that one can continue to have income at a time in their lives when there are not necessarily other earning opportunities available.
If a participant borrows $50,000 of their $100,000 account, how and when will they be able to pay that $50,000 back? And if they employer, that loan is due in full immediately. If they are unable to pay it back, the loan is in default – and that becomes taxable income at the end of the year.
We recommend including a loan feature that allows only one or two outstanding loans to exist at any one time. This stance helps send the message that the money is there if you really need it – but hopefully not many people will need to take an annual loan.
Another section of our SmartPath™ tool takes into account what’s offered to existing participants in the plan. Historically we periodically undertake “employee education meetings,” which explain why a diversified plan is prudent, the benefits of auto-escalation or other ways of increasing one’s salary savings rate, and so on. Offering a re-enrollment option for current participants often makes sense; as previously noted, we like to start auto-enrollment, or re-enrollment with at least 6% of salary going into their 401(k). And, as always, an “opt out” option is included in all of our automated processes.
Most employers prefer to make sure that their plan participants utilize their retirement savings plan properly to best take advantage of its features. This approach not only satisfies current and new employees, but also can be an attractive draw for potential employees.
And not only that, it will also help stave off a new “retirement crisis” like that presented by Frontline’s “The Retirement Gamble.” There should be no “gambling” involved with one’s own retirement; Pentegra’s SmartPath™ is designed to reinforce that belief.
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