 |
By: Ted Benna Creator of the first 401(k) plan |
February 21, 2002
This Week, Ted Tackles:
My employer's contributions outperformed mine by 2 to 1, even though I have contributed more. Why? ... My employer's 401(k) plan flunked the discrimination test and has to return money to the highly compensated employees. How are those refunds determined? ... Can you help me figure out how my company calculated my profit-sharing match? ... I'm a financial advisor. I want to become broker of record for a company that has a bad 401(k) plan, but there's nepotism in the plan administration. What should I do?
|
Q: On reading my 401(k) statement, I noticed that my
employer's contributions outperformed my contributions by better than 2 to 1. Why is that
possible even though I have contributed the larger amount over the years?
A: This disparity is likely due to the fact that
your employer controls how its contributions are invested and you determine how your
contributions are invested. Here are two possible explanations:
1) the company contributions could have all been invested
in its own stock which had a nice rally, or
2) the contributions could have been invested in a
diversified portfolio of stocks which produced a much higher return than the investments
you may have selected because you were much more conservative -- perhaps investing a much
smaller portion of your contribution in stocks.
I recently met with the CFO of a company that controls how
its contributions are invested but allows employees to decide how to invest their own
contributions. The investments that the company controlled have produced a 12.5 percent
average annual return. Suppose a plan participant selected investments that received an 8
percent average return. After approximately 25 years the amount attributable to company
contributions would be more than twice the amount attributable to employee contributions,
even though the participant contributed twice as much during this period.
Q: My employer failed the discrimination test for its
401(k) plan and now has to refund money to highly compensated employees (HCEs) from the
plan. But not all HCEs will receive refunds. My employer says it has the right to choose.
Is this legal? I thought there was a standard formula to
decide who should get refunds, and how much they should be, from a plan that has failed
the discrimination test.
A: You are correct. The employer isn't permitted to
pick which employees are to get refunds. The refunds are to be made to the highly
compensated participant or participants who made the largest contributions. This order is
to be followed regardless of the compensation levels or individual contribution
percentages of the HCEs.
Assume there are only two HCEs. One earns $150,000 and
contributes $9,000. The other earns $100,000 and contributes $8,000. Next, assume the
amount that must be refunded is $1,000. The refund must be made to the employee who
contributed the $9,000 amount even though he contributed only 6 percent of pay compared to
8 percent contributed by the other HCE.
The refund used to go to the HCE who contributed the
highest percentage but Congress changed the law a few years ago so that the excess must be
distributed based upon contribution amounts.
Q: I joined my employer on Oct. 4, 1999 and it
contributes to our 401(k) profit-sharing account annually. At the end of 2000, I received
3 percent of my 2000 salary in my account. I was just informed by my firm that I would
only get 3 percent of my 2001 salary for 2001, while most people in my firm are getting 11
percent. I am grateful for the contribution but puzzled by the process. The explanation
was that 11 percent of my salary between Oct. 4, 2000 to Dec. 31, 2000 is less than 3
percent of my salary from Jan. 1, 2001 to Dec. 31, 2001. Please explain or point me to IRS
rules.
A: The employer is probably contributing 3 percent
of your pay because the plan is "top heavy." This is a condition that exists
when more than 60 percent of the plan assets belong to "key employees." Key
employees often include owners and some top executives. A 3 percent minimum employer
contribution is normally required when this condition exists. The plan probably also has a
discretionary profit-sharing contribution which employees get after completing one year of
service. This contribution is probably based upon the pay you received after you became
eligible. This is a potential reason how 11 percent of your pay from Oct. 4, 2000 to Dec.
31, 2000 would come into play.
It would appear the company made an 11 percent
profit-sharing contribution for eligible employees for the 2000 year. I can't come up with
any reason why th is would impact your 2001 contribution. The applicable contributions
should be determined independently for each plan year. You should receive the same
percentage of pay during 2001 as the other plan participants unless the plan allocates the
employer profit-sharing contribution based upon factors other than just compensation. The
employer could allocate these contributions using age, years of service, or other factors
in addition to compensation. It would be necessary to have all the applicable facts,
including the plan documents, to know exactly whether what they are doing is correct. I
recommend carefully reading the portion of the Summary Plan Description that explains how
employer contributions are determined and allocated among eligible employees. Ask for a
copy of the SPD if your employer hasn't given you one.
Q: I am a financial advisor with a large brokerage firm
concentrating on 401(k) sales. Recently, I was attempting to get a local public company to
make me broker of record on their group annuity contract. The employer's current broker
has taken ridiculous commissions, refuses to conduct out-of-state enrollment/education
meetings, and actually hangs up on employees who call with investment-related questions.
Additionally, the employer is paying high fees, and has failed its non-discrimination test
two years in a row with a third on the way. The plan has no investment policy statement
and participants are not provided with a summary plan description. The participation rate
is less than 25 percent.
The consensus among the human resources staff would be
to remove the current broker of record. However, the current broker of record is the
nephew of the majority shareholder of this potential client, and the HR staff fears that
if the current broker of record is removed, there is a strong possibility that they will
be removed. What do you think that we should do?
A: You have asked what you should do -- my advice is
to move on. You aren't likely to ever win this business unless the situation at the top of
this potential client changes.
As you know, employers are required by the fiduciary
standards contained in the Employee Retirement Income Security Act (ERISA) to act solely
in the best interest of participants. Unfortunately not all employers follow this
standard. I would consider this situation to be a violation of the ERISA fiduciary
standard and other provisions of ERISA based upon the facts you have presented. Yes, these
participants deserve much better treatment, which probably is a major reason why only 25
percent participate. Apparently the employer doesn't care.
 |
Ted Benna, creator of the first 401(k)
retirement savings plan, answers intriguing questions twice a month. With over 40 years of
experience as an employee benefits consultant, Ted is a nationally recognized expert on
benefits issues. He has authored three books, Helping Employees Achieve Retirement
Income Security, Escaping the Coming Retirement Crisis, and Tips for
Successfully Managing Your 401(k), and is President of the 401(k) Association. Ted is
a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and
comments have appeared in numerous publications, including The New York Times and The
Wall Street Journal. |
 Ted's Table Archives
The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
mPower.com is the premier online community resource for
401(k) participants
Copyright ý 1996 - 2000 mPower. All Rights Reserved.
|
