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5500 for larger 401k plans and IRS 401k rules for smaller 401k plans, - Overview of IRS Form 5500 Annual Return/Report, - Profile of IRS Form 5500, - Recommended 401k
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www.401kcensus.com for information about 401k Census "blind samples" investment and contribution data from many thousands of individual 401k investors and posts the results in this free public website for the benefit of 401k investors

 

Commentary

401K PLAN TAKEOVERS AND 401K CONVERSIONS

Background

401(k) Plans

A section 401(k) plan is a type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pre-tax basis. These deferred wages (commonly referred to as elective deferrals) are not subject to income tax withholding at the time of deferral, and they are not reflected on Form 1040 since they were not included in the taxable wages on Form W-2. However, they are included as wages subject to social security, Medicare, and federal unemployment taxes.

The amount that an employee may elect to defer to a 401(k) plan is limited. During 2004, an employee cannot elect to defer more than $13,000 for all 401(k) plans in which the employee participates. But if the employee participates in a SIMPLE 401(k) plan, the limit for 2004 is $9,000. Both of these limits are indexed for inflation. In addition, if the 401(k) plan permits participants age 50 or over may be eligible to make additional "catch-up contributions" to the plan of up to $3,000 in 2004 ($1,500 for SIMPLE 401(k) plans) under section 414(v). Generally, all deferred compensation plans (such as a 401(k) plan and 403(b) plan) in which the employee participates must be considered to determine if the $13,000 limit is exceeded. All contributions to retirement plans (including deferred compensation plans) are subject to additional limits. Therefore, your elective contributions may be limited based on the terms of your 401(k) plan.

Distributions from a 401(k) plan may qualify for optional lump-sum distribution treatment or rollover treatment as long as they meet the respective requirements.

Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship distributions from a 401(k) plan are limited to the amount of the employee's elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.

Distributions received before age 59 1/2 are subject to an early distribution penalty of 10% additional tax unless an exception applies.

401(k) plans are arguably the best government-sanctioned, tax-deferred retirement savings opportunities in the United States; their numbers have grown commensurably since their institution by Congress in 1978. One estimate, by CHALK 401(k) Advisory Board, Inc., places the number of qualified 401(k) plans in 1997 (the last year surveyed) at 225,000, and the number of participants in those plans at approximately 28 million; the Investment Company Institute (ICI) estimates 36.7 million participants in 1998. New plans continue to grow in number at an annual rate of more than 14% (U.S. Department of Labor).

The tax deferral of 401k has a huge compounding effect: $150 per month put into a typical taxable savings account paying 8% annual interest will grow to $42,034 by the end of 20 years (assuming a combined federal and state personal income tax rate of 34%). In a 401(k), however, the same deposits earning the same rate of return during the same 20 years will yield $88,353 . Even if that amount is taxed at the 34% rate when the money is withdrawn from the plan, which is unlikely if the participant is retired, the 401(k) participant will walk away with more than $16,000 compared to the equivalent non-401(k) investment return.

The average 401K account balance at the end of 1998 was $47,000 per participant, up 26% from 1996, according to the ICI and the Employee Benefit Research Institute. On average, 78% of eligible employees will participate in a 401(k) plan if one is made available, with the number of participants growing from 19.5 million in 1990 to 53.2 million in 2000. Some of the increase in participation rates is due to the introduction of "negative election," which allows an employer to automatically enroll employees into the 401(k) when they meet the plan's eligibility requirements. The negative election deferral rate and investment(s) must be defined ahead of time, and the employee must be immediately notified of his or her participation status. Automatic enrollment programs are sanctioned by the IRS under ERISA as long as the employee has ample ability to cease enrollment at will.

A comprehensive 401(k) administration software system should contain the following:An IRS-approved prototype 401(k) plan customized to the client's specifications. Employers select their plan participation requirements, matching contribution rate (if any), vesting rate for matching contributions (if any), and more in ordering their plan. Free help is available with understanding and choosing among options; final choices are hardwired into the client's software. The client's choice of plan investments. Self-directed discount brokerage accounts and/or no-load mutual funds or load mutual funds.

A comprehensive 401(k) administration software system should contain the following: Plan-customized forms and documents needed by the employee-participants and the plan administrator (enrollment forms, loan applications, asset liquidation authorizations, etc.). All relevant processing functions take into account the hardwired employer choices. Current IRS regulations are embedded in the software, too. The system is updated each year to reflect any regulatory or other changes; clients receive updated copies of both software and companion materials upon renewal.

A comprehensive 401(k) administration software system should contain the following: A CD-ROM that contains the necessary forms for reporting to the IRS, with both blank and completed sample copies provided. Literature and a video which explain the plan in detail, including information on the benefits of investing in a 401(k), how to assess investment risk, how to choose among the available investments, etc.

A comprehensive 401(k) administration software system should contain the following: An easy-to-read-and-follow user's guide that explains exactly what the employer needs to do and how to use the system to do it. A supplement to the guide provides additional details and background information. Free help in getting the plan up and running. Everything except investment choice and performance, and the one-time setup fee, is covered by a 60-day money-back guarantee

The three primary reasons why 80% of America's small businesses do not offer 401(k) plans to their employees are: (a) perceived cost of employer-sponsored retirement plans, (b) perceived complexity of company-sponsored retirement plans, and (c) limited investment options. Mutual fund companies offering 401(k) plans to small businesses do so by pre-packaging administration with their proprietary fund investments; this pre-packaged approach, called "bundled 401(k)" tends to be pricey for small companies, limited features and limited investment options. Employees who participate in bundled 401(k) plans typically do not have access to investments not offered by the mutual fund company, and do not have access to the most popular investment option today-the individual self-directed discount brokerage account.

According to HR Investment Consultants in Towson, MD, publisher of the "401k Provider Directory, "the cost of running a 401k plan with 25 participants and $750,000 in assets can range from as little as $6,750 per year to as much as $20,000, depending on which 401k vendor you select. (Sources: Nation's Business, September 1998, Myers, Randy "Your 401k Plan May Cost You Too Much." Business Week Online, July 2000, Brenner, Lynn "A Wealth of Choices."). By comparison, a 401(k) Easy or Easy Online system costs only $995 pear year for a 25-person plan---a savings of between 60% and 80% in plan administration fees

401K PLAN CONVERSIONS

401(k) plans are arguably the best government-sanctioned, tax-deferred retirement savings opportunities in the United States; their numbers have grown commensurably since their institution by Congress in 1978. One estimate, by CHALK 401(k) Advisory Board, Inc., places the number of qualified 401(k) plans in 1997 (the last year surveyed) at 225,000, and the number of participants in those plans at approximately 28 million; the Investment Company Institute (ICI) estimates 36.7 million participants in 1998. New plans continue to grow in number at an annual rate of more than 14% (U.S. Department of Labor).

Employees rank 401(k) plans second only to health benefits when it comes to employer-offered benefits they desire. 401(k)s offer employees an unmatched long-term savings potential, primarily because neither 401(k) contributions nor their earnings are subject to income tax during all the years plan participants contribute before retirement.

401(k) plans have the highest annual contribution ceiling of any of the tax-deferred defined contribution savings programs (IRAs, SEPs, etc.). More money contributed equals more money earning money, equals more money in the account 20 years later. Add to this earning potential the convenience of contributions made through automatic payroll deductions and it's easy to see why 401(k)s are so popular

The average 401K account balance at the end of 1998 was $47,000 per participant, up 26% from 1996, according to the ICI and the Employee Benefit Research Institute. On average, 78% of eligible employees will participate in a 401(k) plan if one is made available, with the number of participants growing from 19.5 million in 1990 to 53.2 million in 2000. Some of the increase in participation rates is due to the introduction of "negative election," which allows an employer to automatically enroll employees into the 401(k) when they meet the plan's eligibility requirements. The negative election deferral rate and investment(s) must be defined ahead of time, and the employee must be immediately notified of his or her participation status. Automatic enrollment programs are sanctioned by the IRS under ERISA as long as the employee has ample ability to cease enrollment at will.

Many small and medium-sized companies that have 401(k)s have a bleak future: many are being canceled because they are not profitable enough a service for vendors to maintain; in other cases, service is not being canceled but the level of service is so disproportionate to the high fees being charged that employers themselves must pull out or endure the aggravation of continually feeling they are being overcharged. The company estimates there are more than 400,000 very small, small, and medium-sized companies that (a) have no plan, (b) have had their plan canceled or have canceled their plan, or (c) have a plan they are unsatisfied with.

Internet penetration and usage by small businesses is a key component of 401(k). According to a survey conducted by IDC, Internet usage by small businesses reached 62% in 1998. Total small business spending on Internet related applications is expected to increase from $6.6 billion in 1998 to 418.2 billion by 2002, yielding an annual growth rate of 45%.

Recordkeeping firms represent a small and possibly decreasing fraction of the available market. These firms tend to be local and regional, and although they can maintain the "human touch," they cannot compete effectively with the bundled plans offered by mutual fund companies.

The three primary reasons why 80% of America's small businesses do not offer 401(k) plans to their employees are: (a) perceived cost of employer-sponsored retirement plans, (b) perceived complexity of company-sponsored retirement plans, and (c) limited investment options. Mutual fund companies offering 401(k) plans to small businesses do so by pre-packaging administration with their proprietary fund investments; this pre-packaged approach, called "bundled 401(k)" tends to be pricey for small companies, limited features and limited investment options. Employees who participate in bundled 401(k) plans typically do not have access to investments not offered by the mutual fund company, and do not have access to the most popular investment option today-the individual self-directed discount brokerage account

According to HR Investment Consultants in Towson, MD, publisher of the "401k Provider Directory, "the cost of running a 401k plan with 25 participants and $750,000 in assets can range from as little as $6,750 per year to as much as $20,000, depending on which 401k vendor you select. (Sources: Nation's Business, September 1998, Myers, Randy "Your 401k Plan May Cost You Too Much." Business Week Online, July 2000, Brenner, Lynn "A Wealth of Choices."). By comparison, a 401(k) Easy or Easy Online system costs only $995 pear year for a 25-person plan---a savings of between 60% and 80% in plan administration fees.

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