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Articles: Is your 401(k) on autopilot?

The basic benefits of 401(k) plans are well-known. Significantly, you can defer part of your salary to an account on a pretax basis.  The contributions are invested and may be able to grow without any current tax erosion until you make withdrawals.  This may enable you to save a sizeable amount for retirement.

However, if you are a highly compensated employee, you may be hindered by special nondiscrimination rules if enough employees do not join in the plan. Common occurance:  Due to recent volatility in the equities markets, some employees have shied away from participation. But this hurdle may be overcome through the use of an “automatic enrollment” 401(k) plan.

How it works:  Deferrals to 401(k) accounts are made on behalf of employees if they do not proactively opt out of the plan.   Therefore, it becomes more likely that the required levels of employee participation are met. Furthermore, severall recent legislative changes may enhance the automatic enrollment feature.

For starters, an employee can defer up to $17,000 to a 401(k) plan in 2012. If you are age 50 or older, you can contribute an extra $5,500 this year, for a maximum total contribution of $22,500.

An employer may choose to provide matching contributions up to certain levels. These contributions can also grow on a tax-deferred basis.

In additon to the usual requirements for qualified retirement plans, a 401(k) plan must meet an actual deferral percent age (ADP) test for pretax contributions and an actual contribution percentage (ACP) test for matching contributions.  If the 401(k) plan fails either test, the employer must make corrective distributions to highly compensated employees or provide extra contributions for nonhighly compensated employees.

Note:  Under a special safe harbor rule, the employer may provide minimum contributions of at least 3% of compensation to nonhighly compensated employees.

The automatic-enrollment feature generally results in more employees participating in the plan.  So both the ADP and ACP tests may be satisified as a result.

Under the Pension Protection Act of 2006 (PPA), several rules relating to automatic-enrollment plans have been liberalized. For example, the PPA overrides state laws that could interfere with the operation of an automatic-enrollment plan. Also, plan fiduciaries are relieved of their fiduciary responsibility for investing employee contributions when the employee fails to make an investment election if contributions are invested in a qualified default alternative.  Another change authorizes a safe harbor from testing if certain technical requirements are met.

Obviously, this is a complex area of the law.  If you are in a position of authority, consult a benefits advisor about the implementation of an automatic-enrollment plan.

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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