Establishing the optimal workplace retirement plan follows a pecking order, which starts by prioritizing plan design over investments. Our Mike Dullaghan discusses the process.
Whether from my favorite chair in our den or from my spot at the kitchen table, I have a good view of our deck. When we have bread products past their “use by” date we break apart the bread and place it in on the railing for the birds. I have noticed there is a pecking order when the birds come to eat. The littlest birds come first, the cardinals and blue jays come next, and then the big crows come in for “cleanup” detail. Occasionally, the birds come “out of order” and a ruckus ensues until proper order is restored.
Watching the birds jostle for position reminds me there is a proper order to design a successful 401(k) plan. While it is tempting to start with a plan’s investments, these are not as important to the success of the plan as the structure of the plan itself.
The right plan design is crucial for making a 401(k) effective for both owners and employees, addressing both near-term and long-term objectives. This is particularly important for small businesses, where profits often pass through to the owner’s individual tax return. Profitable businesses present plan design optimization opportunities.
Focus on features before funds
Plan design determines key components of the plan, such as employee eligibility, automatic features (auto-enrollment and auto-escalation), whether the employer wants to match any contributions, and by how much, vesting schedules, profit-sharing, and the contribution limits for business owners and key employees. Notably, eligible plan expenses are business expenses that may be tax deductible for the business, thereby lowering pass-through taxable income to the business owner.
The good news is that plan design experts are available to help you and your client find features that make the most sense. Third-party administrators (TPAs) can gather data and goals from your client to identify plan features that are customized for their situation. Often, basic information on the ages of employees and incomes, when combined with the owner’s goals, goes a long way in optimizing features.
What is key about the chart above, is the “traditional 401(k)” category contains variations. For example, there are other creative options to meet a client’s unique needs, including profit sharing plans, cash balance plans, age-weighted plans, and Social Security integrated plans. It’s important to know that options exist. Your TPA partner will sort out which option is best-suited for optimization.
The pecking order: Prioritizing plan features
Just as birds establish a pecking order, financial professionals must prioritize certain plan features based on the needs of their participants and business-owner clients. This could mean emphasizing employer match programs to encourage participation, offering Roth 401(k) options for tax diversification, including automatic escalation to help participants increase their savings rate over time, all while maximizing the tax benefits of offering a plan.
In conclusion, optimizing a 401k plan design is a delicate balancing act, much like maintaining the pecking order within a flock of birds. By keeping the needs of all participants in mind and prioritizing the right plan features, financial professionals can create a 401k plan that prioritizes employee outcomes while meeting business owner objectives.
Next steps for financial professionals:
- Ask every business-owner client, “How happy are you with the tax efficiency of your company’s retirement plan?”
- Listen intently for business owners who do not have plans or have not recently analyzed their current plan from this perspective.
- Remember, your goal is to start this conversation to reach agreement to set up a plan design consultation call with a TPA with your recordkeeper partner. You do not need to be a plan design specialist.
- Ask anyone you know with an existing plan, “How happy are you with the amount you and your key employees have been able to contribute to your retirement plan in recent years?”
- Often a three- to four-year-old plan has not been reviewed for design optimization. One sign of an out-of-date plan design is when owners and key employees are unable to maximize the use of the plan.
- Ask anyone you know who doesn’t have a plan, “If you could potentially lower your personal tax liability and receive tax credits to offset the costs of running a retirement plan, how interested would you be in learning about these plan design features?”
I am not a plan design specialist. However, I know where to turn for plan design help. The momentum that exists in new plan formation and plan optimization means we all need reliable partners to efficiently win as often as possible. Your Franklin Templeton Workplace Retirement Solutions team is ready to partner to ensure your retirement plan success.
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Originally Posted August 28, 2024 – The pecking order of 401(k) plan design: A bird’s eye view
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