The future of the 401(k) Featured

7:00pm EDT November 25, 2007

No matter what point you are at in your career, it’s always a good time to plan for the future. All employees need to adequately plan for retirement, no matter how much they earn. Yet, while most people know they need to be prepared for retirement, many people don’t know how to properly prepare.

Several options are available to employees, such as pension plans, 401(k) plans and IRAs. Luckily, more and more employers are taking an active role in retirement plans, offering new and redesigned plans to help employees prepare for tomorrow and beyond.

“Retirement plans take a lot of time and effort — from both employees and employers — but when they’re done right, they can have amazing results,” says Dale R. Vlasek, a member and chair of the Employee Benefits Practice Group of McDonald Hopkins LLC.

Smart Business spoke with Vlasek about the future of retirement plans and what employers and employees can do to maximize their golden years.

Is there something wrong with 401(k) plans?

That is something that has been debated lately, but, for what they are, 401(k) plans are good programs. The issue is that all retirement plans are subject to various nondiscrimination rules and regulations. By law, employees are split into two groups: highly compensated employees [those who own more than 5 percent of the company or earn over $100,000 per year] and nonhighly compensated employees [everyone else].

The issue concerning 401(k) plans is that there is a limit to how much money highly compensated employees can put into 401(k) plans, based on how much money the nonhighly compensated employees put in it. In simple terms, we’re looking at a spread of about 2 percent. So, if, on average, nonhighly compensated employees put in 3 percent, then highly compensated employees, on average, can put away 5 percent. The major issue is that, generally, nonhighly compensated employees usually don’t have a lot of disposable income, so they can’t afford to put a lot into 401(k) plans. This then limits a highly compensated employee’s ability to save.

Is it possible for employees or employers to contribute more money to retirement plans?

There are good ways for employers to get employees to contribute more, such as automatic enrollment, where all employees are enrolled in 401(k) plans no matter what. There are also ways to design plans so that designated executives or employees can contribute more to 401(k) plans.

In 2007, the largest amount of money that can be contributed to a 401(k) plan, as a combination of employee and employer contributions and any forfeitures, is $45,000 or 100 percent of pay — whichever is lower. But, employers can design programs that say they’ll give a certain employee a $45,000 contribution, so the employee doesn’t have to contribute anything. This can be a wise use of company dollars, because you can take care of your highly compensated employees without worrying about how much the nonhighly compensated employees are contributing to their 401(k) plans. Of course, the discrimination rules would require contributions to nonhighly compensated employees. But, with proper design, the cost of those contributions can be kept at affordable levels for employers.

Is there a place for defined benefit pension plans in the 21st century?

Absolutely. In fact, the only way to put more money in a 401(k) plan, above the $45,000, is through defined benefit plans. You hear a lot today that defined benefit plans are dead. And for a lot of blue-collar workers, that may be true, but there is still a place for them. For instance, the formula of a defined benefit plan is designed to give an employee a sum of money when he or she reaches retirement age, let’s say age 65. Generally, a retirement plan needs to have $1 million in it for the employee to retire comfortably. So, if employees start a plan when they are 20, they have 45 years to get that million. But, if they start when they are 50, they only have 15 years. Defined benefit plans will give those 50-year-olds the ability to put away a lot of money in a short amount of time. Besides benefiting the employees, defined benefit plans help companies because they can provide even more retirement benefits, without violating 401(k) laws.

Where else can you use these more sophisticated plans?

You can use these plans as ways for employees to shelter additional dollars, so they can adequately prepare for retirement. Also, you can structure defined benefit plans so that, for instance, when a son is buying out a father, part of the purchase price, if you will, can be a defined benefit plan that takes care of the parents in the future. That way, a company gets paid for, or a portion of it gets paid for, with tax-deductible dollars.

DALE R. VLASEK is a member and chair of the Employee Benefits Practice Group of McDonald Hopkins LLC. Reach him at (216) 348-5452 or dvlasek@mcdonaldhopkins.com.