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Articles: Gearing up for auto-enrollment plans

Both employees and employers can benefit from a 401(k) plan.  For the employee: You can defer up to $17,500 of salary to  your account in 2014 ($23,000 if age 50 or older) in addition to "matching" employer contributions.

Contributions may grow without any tax erosion until they are withdrawn.  For the employer:  A 401(k) is less costly to fund than the other plans, and most can be a way to attract and retain employees.

But 401(k) plans are subject to strict nondiscrimination testing.  If your company's plan doesn't measure up, certain highly compensated employees (HCEs) might be penalized. This may occur if you don't have a sufficient number of non-HCEs participating in the plan.  However, your company may use an automatic enrollment plan designed to encourage a higher level of participation among non-HCEs.

How it works: Usually, an employee must proactively elect to participate in a 401(k) plan. An automatic enrollment plan takes a different approach.  If employees do not make any election, they are considered to be participants. Thus, you have to choose to opt out of the plan not the other way around.

With an auto-enrollment plan, it is likely that a higher percentage of non-HCEs will participate.  Under a safe harbor rule, your company can provide minimum contributions on behalf of these employees equal to 3% of compensation.

This change may be sufficient to satisfy the nondiscrimination tests on behalf of HCEs.  Also, "forced savings" may help non-HCEs to build a retirement nest egg.

A plan provider, third-party administrator or consultant can help revise the paperwork needed to install this feature. Typically, the plan will provide low-risk default investments divided among diversified mutual funds. Of course, employees are free to make other investment choices.

But the auto-enrollment feature is not without potential drawbacks.  For instance, the company may set a relatively low default rate to encourage contributions.  If you do nothing, you might ride along with that rate for years while you could be saving more for retirement.  Similarly, if you simply accept the investment choices established as the default, you may not be optimizing your earnings.

Practical approach:  With professional guidance, you can make informed decisions taking your personal situation into account, even if your 401(k) plan uses an automatic enrollment feature.  Do not hesitate to ask for assistance.

This newsletter/advertisement is produced for our clients, friends and associates through an arrangement with WPI Communications, Inc. for the representatives’ use. Although the editorial content is professionally researched, written and edited, neither our firm nor any of its agents, representatives or associates make any representations regarding the accuracy of the content or its applicability to your situation. The information in this communication is not intended as tax or legal advice. In accordance with IRS Circular 230, the information provided herein may not be relied on for purposes of avoiding any federal tax penalties. Any tax advice contained in the body of this material was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing or recommending to another party any transaction or matter addressed herein. You are encouraged to seek tax or legal advice from an independent advisor.

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