Defined contribution retirement plan design: An opportunity too good to miss

By David Wray

Defined contribution retirement plan design is an opportunity too good to miss, says David Wray.

In our rapidly changing world a defined contribution (DC) plan can be more than just another employee benefit. It can be the cornerstone of a progressive personnel policy. Companies that have successful DC plans report they have improved profits, increased efficiency, lower turnover and an overall climate of better employee relations. Just as when employees lose the benefit of employer money when they choose not to participate in a 401(k) plan, companies not taking advantage of DC plan design opportunities leave significant benefits on the table as well. Have you evaluated your plan design lately?

DC plans are not just a form of bonus or a retirement plan, though they can contain these features. They are part of a progressive management personal program designed by management to increase productivity, improve efficiency, reduce turnover and increase profits. It is important to identify and prioritize management’s objectives before the company considers its DC plan design. What are the objectives? – incentivizing the workforce, reduction of turnover or absentees, improved product quality, increased cooperation, retirement security? By listing the objectives you will be better able to determine the plan features that will help achieve them.
 
The first step in DC plan design evaluation is to understand the organization’s culture and its policies about its workforce. For example, does the organization want to hire the very best employees available and is it willing to provide above market average compensation and benefit packages to get them? It is critical to have an employee census. Ideally, the census will include the age, compensation, marital status and tenure of each employee. Some companies also survey their employees for input as well.

Aims and objectives

Does the company want to improve retention, motivate its workforce or both? The DC plan promotes retention but only among those who participate. Matching contributions promote participation. According to PSCA's 52nd Annual Survey of Profit Sharing and 401(k) plans, 80 percent of DC plans include matching contributions. As the eight year National Bureau for Economic Research study published this year in Shared Capitalism At Work reports, company contributions tied to profitability can increase productivity and a firm's financial performance. PSCA's Annual Survey found that 33 percent of defined contribution plans included profit-sharing based contributions for all eligible employees companies. 20 percent of plans with matching contributions condition some, or all, of the match on profitability.

Various methods can be used in determining how company money is divided among its employees. While federal law prohibits discrimination as defined by the government in favor of higher paid employees there is still significant plan design flexibility. The most common method of allocation is to utilize the same percentage of pay for all employees. This is true for both matching and non-matching contributions. However, the law permits other approaches. Plans can use what is called Social Security Integration, which allows a company contribution of one percentage of pay up to the Social Security taxable wage limit and another higher percentage based on amounts of compensation over that limit. Plans can also weight the company contribution for service and age.

The employer has significant flexibility in designing the plan’s matching formula. With some workforces a modest match can lever significant employee savings. In others the employer needs to incentivize employee savings with a dollar for dollar matching contribution. A few go as high as providing two dollars or more of company contribution for every dollar of employee contribution. As an example of this flexibility, one company matches 25 percent of an employees’ voluntary contribution up to eight percent of pay for those with five years of service or less. It escalates the matching percentage as a participant’s tenure increases culminating with a 100 percent match on eight percent of pay for participants with 15 or more years of service.

The percentage of companies permitting participation by all employees over the age of 21 with one year of service has been increasing and is now over 50 percent. However, some companies have decided to exclude certain categories of workers, such as commissioned sales staff or those working less than a thousand hours a year.

Also, to aid in recruiting companies are increasingly permitting employees to participate in their 401(k) plans when they join the company. In 2005 approximately 65 percent of sponsors permitted participants to begin making voluntary contributions to their plans within three months or less of when they started to work. That percentage had increased to 76 percent in 2009 according to PSCA’s Annual Eligibility Survey released in the fall of 2009. Furthermore, 44 percent of plans no longer have a minimum age requirement.

Vested interest

The employee’s vested right to employer contributions to a DC plan varies. A participant can acquire a fully vested interest in his or her account from the time the company contribution is deposited, or the ownership of company money can increase gradually over a period of years. If a primary purpose of the plan is retention then requiring employees to work several years before they fully earn the company contribution can be a successful tactic. If the employer wants to use the company contribution to attract new employees then giving them ownership of the company contribution immediately can make more sense. According to PSCA's 52nd annual survey, 37 percent of companies provide immediate full vesting for matching contributions and 26 percent provide immediate full vesting for profit sharing contributions.

The law permits that when financial emergencies arise an employee can be permitted withdraw their DC account balance. It also permits participants to borrow up to $50,000 or half of their account balance, whichever is lower, from their plan. In-service access to account balances increases participation and savings rates. PSCA's 52nd annual survey found that 90 percent of plans permit hardship withdrawals and 86 percent permit plan loans. Plan sponsors need to evaluate whether these features make sense at their company.

Trends and conclusions

There are well established DC plan trends that will continue without interruption for another year as plan sponsors build on 2008 and 2009 – even in these times. As a strategy to build DC plan participation, the use of automatic enrollment is growing. According to PSCA's 52nd Annual Survey 56.3 percent of large companies have automatic enrollment. That percentage will increase in 2010.

The complexity of the investment choice can lead to inappropriate allocation and even suppress plan participation. As a reaction the long-established trend to more and more investment options in DC plans has ceased. According to PSCA’s 52nd Annual Survey the number of funds available for participant contributions in 2008 remained the same as the previous two years – 18 funds. It is expected that the average number of funds in plans will show a decrease in 2010. Sponsors are also moving to provide automatic investment solutions and advice to participants. The availability of target-date funds increased to 57.7 percent of plans with 73.2 percent offering some type of managed investment option in 2008. In 2008 51.8 percent of companies offered investment advice to participants.

To assist with recruiting and retention, more companies are introducing a Roth feature into their plans. According to PSCA's 52nd Annual Survey among plans that permitted participant contributions, 36.7 percent allowed participants to make Roth after-tax contributions, up from 18.4 percent in 2006. Plan sponsors reported that 15.6 percent of participants made Roth contributions when offered the opportunity, up from 12.6 percent in 2007.

How will health care reform affect employer-provided benefit programs? Some predict that many employers, especially smaller employers, will terminate their health care programs. If there is no health care benefit as an HR tool DC plans will be considerably more important. But why wait. Design your plan to attract and retain and motivate a high-quality workforce and take advantage of a DC program that is all that it can be.

David Wray is President of the Profit Sharing/401(k) Council of America (PSCA).