PS Coach | Published in May 2017

Participant FAQ's

How should plan sponsors respond?

By Rebecca Moore | May 2017
Art by Melinda Beck
Retirement plan participants will always have questions, and plan sponsors, as fiduciaries, should have proper answers when these arise. Below are some common queries, and suggestions for how you might respond.
Q: How much should I save in my plan?
A: Lori Lucas, Chartered Financial Analyst (CFA), executive vice president and defined contribution (DC) practice leader at Callan Associates in San Francisco, advises plan sponsors to impress upon participants that a good way to determine how much to save in their defined contribution plan is to use a retirement calculator. The good ones will provide a reasonable estimate of what the person will need in retirement and make recommendations to help meet that goal. The plan sponsor should point to a calculator available on the plan’s benefits website or note that such tools are available for free elsewhere online. “Of course, they should also explain that, at a minimum, people should by all means contribute enough to receive their employer’s full matching contribution,” she says. Plan sponsors can point to this amount in the plan’s summary plan description (SPD) or other plan education materials.

Q: What is the difference between a regular deferral and a Roth deferral? Which should I use?
A: Bruce Ashton, attorney at Drinker, Biddle & Reath LLP in San Francisco, suggests plan sponsors explain that a regular deferral is an amount taken from a participant’s salary, pretax—i.e., before that income is taxed. He will pay tax on the deferrals, plus any earnings, at the tax rate in effect when he takes the money out.
A Roth deferral is an amount taken from a participant’s salary after the income is taxed—i.e., after-tax. Assuming the money remains in the plan for at least five years, when the participant takes it out, he pays no income tax on either the deferrals or on what they have earned.
“The ‘which should I use’ question is more difficult to answer,” he says. Participants can be told to ask themselves whether paying income tax on deferrals upfront will put them in a financial bind, or whether they can comfortably do so, plus pay all of their living expenses, including entertainment, travel and the like, and still have money left over. Plan sponsors should tell participants, “There are many trade-offs between regular and Roth deferrals, and which you choose depends on your current financial situation and desired results later on,” he says.

Q: What is the net effect on my take-home pay if I defer into the plan?
A: “With pre-tax contributions, participants will forgo paying taxes on the money they contribute to the plan,” Lucas says. “For example, if their marginal tax rate is 25% and they contribute $1,000, they would save $250 in taxes, making the actual cost of pre-tax contributions effectively $750.” A Roth deferral decreases their pay by the actual deferral amount, as tax on their income is paid before the money is deferred.
Q: Where in the plan should I invest my money?
A: “This may be one of the toughest questions of all for plan sponsors to answer,” Lucas says. Assuming the plan has a default fund such as a target-date fund (TDF) alongside the core investment lineup, if a participant is afraid to make that decision and would like someone to do it for him, she suggests that plan sponsors explain that the target-date fund or other default will assume that task.
If, however, a participant is comfortable making the choice, the core investment funds are available for do-it-yourselfers who wish to design their own diversified investment portfolio based on their risk profile. Then, plan sponsors can point to all of the resources available to help people select the appropriate target-date fund or create their own investment portfolio.
“These might include online education, in-person meetings, fund factsheets, guidance tools, advice or managed accounts,” Lucas says.

Q: Can I get my money out if I have an emergency?
A: “Plan sponsors want to assure people that they can access their money if they need to. But, on the other hand, they don’t want to position the plan as an ATM to be accessed regularly for nonemergency reasons,” Lucas notes.
She recommends clarifying the difference between the options that may be available such as hardship withdrawals and loans. For example, she says, plan sponsors could say, ‘Your plan allows you to access your money in the event of an emergency—even if you are younger than the age 59 1/2 withdrawal requirement—via loans or hardship withdrawals. You may borrow up to 50% of your balance, to a maximum of $50,000, via a plan loan. Hardship withdrawals are also available, so you can access your savings if you have a[n emergency] such as the potential loss of your home. Hardship withdrawals are subject to taxes and a 10% penalty; loans are not—provided they are repaid. In addition, interest paid on your 401(k) loan goes into your 401(k) account.’
Plan sponsors should underscore for participants that the defined contribution plan’s true role is as a critical source of retirement saving, and it generally should be viewed as an emergency fund only as a last resort, Lucas says.

Q: If my plan doesn’t allow loans, why can’t I still get my money?
A: In this instance also, plan sponsors should explain that the point of a defined contribution plan is to save for retirement, Ashton says. Plan sponsors should note that the law says participants may withdraw retirement savings only under limited circumstances, including a death, disability, termination of employment, retirement and, as discussed above, if the plan permits loans or hardship distributions. Further, if the plan allows this, they may withdraw their money when they reach age 59 1/2, even without experiencing any of the other “distributable events.”
Q: What happens to my 401(k) investment if my company goes out of business?
A: According to Lucas, it may be enough just to assure employees that defined contribution plan contributions and earnings are kept in an individual trust account—apart from their employer’s assets—which belongs to the plan participants regardless of their employer’s fate. Plan sponsors also may want to explain that, if their company should go out of business, the plan’s administrator—which is typically a third party—would be responsible for maintaining the plan.

Q: May I roll my previous retirement account or an individual retirement account (IRA) into this plan?
A: Here, plan sponsors would let participants know whether their defined contribution plan allows for rollovers to be made into the plan, Ashton says.
Q: Why can’t I choose other investment funds? Why can’t we have a brokerage window?
A: “It is important to explain that the plan’s sponsor is responsible for selecting and monitoring the investments available in the plan—with the best interest of participants in mind,” Lucas says. Note that the fund lineup has been created to provide participants with the ability to design a well-diversified investment portfolio that is appropriate to their risk profile.
As for the second question, while a brokerage window can provide access to a broad array of mutual funds or even individual securities, plan sponsors may point out that there are also drawbacks, Lucas says. “For example, a brokerage window may subject participants to additional costs; brokerage windows can be challenging for participants to use; the investments in the brokerage window generally do not have the same oversight by the plan sponsor as the investments in the ‘core’ fund lineup; and few people ever actually use a brokerage window,” she says.
Q: What happens to my plan loan(s) if I leave or get let go?
A: The answer depends on how the plan sponsor has decided to treat loans; some plan sponsors have started allowing terminated participants to pay loans back to the plan after termination.
If this option is unavailable, Ashton says, plan sponsors should explain that the loan will be due in full if the participant’s employment terminates. That means he either has to pay it off or the unpaid balance will be added to his taxable income for the year.
Q: What is a vesting schedule? What does “vesting” mean?
A: Lucas says the best way to start is with a definition: “Vesting is your right of ownership to the money in your account.”
Next, describe how it works: “The money that you save from your paycheck is always fully vested, meaning it belongs to you even if you leave the company.” If employer contributions are not immediately vested, plan sponsors can explain that there is a schedule of how much an employee “owns” of the employer contributions to his account with the completion of each year.
According to Lucas, plan sponsors can point participants to the plan’s SPD to view the vesting schedule, and plan sponsors should note that if a participant leaves the company before its contributions have been fully vested, the amount not vested will be returned to the plan.