By Jessica Angell, plan administrator, Blue Ridge ESOP Associates
You just received the dreaded call from your friendly 401(k) third-party administrator – your average deferral percentage (ADP) test is failing…again! Some of your highly compensated employees will be disappointed to learn that money they deferred will be returned to them and is taxable.
A common reason for a failed test is a low employee participation rate among the non-highly compensated employees. The million dollar question is: "How can I increase employee participation?" Follow some of these tips and you may be on the road to passing the ADP test soon!
- Educate your new employees. Do you currently provide your new employees with information about the 401(k)? We're not just talking about handing them an enrollment packet and a summary plan description along with their other new hire paperwork, but really promoting the plan to your new employees. Examples include group meetings, posters in common areas of the workplace, e-mails, payroll stuffers and other communication to actively promote the plan.
- Educate your current employees. Hold meetings with employees right before or in conjunction with your benefit open enrollment. Employees need to be reminded about the need to save for retirement at least annually. Sometimes new employees don't initially enroll in the 401(k) plan because they are either overwhelmed with all the new hire paperwork or decide to wait until they can assess their financial situation. They may not realize they can begin deferring at a later time. If you have a "hands-on" financial advisor, he or she may be willing to assist in this area. Ideally, your financial advisor would explain plan features and assist with enrollment. Provide illustrations on how a small amount deferred today can compound over time. If you have a match, explain it! The following example demonstrates the power of a 25 percent match rate: Would you put $1.00 into a Coke machine if you could get the machine to dispense $1.25? That's what happens when contribute to our 401(k) plan.
- Provide automatic enrollment. Amend your plan to provide that new employees are automatically enrolled at a pre-determined percentage of pay (e.g. three percent default rate) unless they make an affirmative deferral election. Studies show that automatic enrollment increases participation when coupled with suitable default investments and matching contributions. For example, provide a six percent default contribution rate with a default target date fund that is matched to the employee's expected date of retirement. Pair automatic enrollment with an annual one percent increase in the default deferral rate. When you initially adopt automatic enrollment, consider applying it to new participants and existing participants who are not currently contributing to the plan.
- Provide a match. A match has strong appeal, even when the company only matches a dime on the dollar. The larger the match, the bigger the impact on enrollment. Consider a stretch match. If you need for employees to contribute five percent of pay on average in order to pass ADP testing, consider a match formula like 20 percent of the first five percent of pay contributed.
- Simplify enrollment. Provide key information about the plan. Ensure that the investment menu and enrollment materials are not overwhelming. Highlight a default investment option or the plan's target date funds or risk-based asset allocation funds (i.e., conservative portfolio, moderate portfolio, etc.) Consider the need for materials in Spanish or other languages. When possible, take enrollment to employees if they work at various sites.
- Re-evaluate investment options. Employees may be more willing to defer if the plan offers investments that meet their personal objectives – as long as the list of options is not too long. Participants will postpone enrollment if they are looking at a menu of 40 options. Including target date funds may be a draw for your employees with less experience in making investment decisions.
Following these suggestions is not a promise that your future ADP tests will pass, but they will get you on the right path to increasing participation.