I have friends who work part-time for different reasons (realizing that the definition of “part-time” may vary from one employer to another). During a recent conversation with one of my friends (I’ll use the name “Becky”), we discussed the topic about having enough retirement savings to retire at our “normal retirement date,” and even better, being able to retire comfortably. I was sorry to learn that Becky’s employer’s 401(k) plan didn’t cover her – and was even more sorry to hear that retiring didn’t seem to be much of an option for her!
A few days later I was talking with another friend (who I also knew worked part-time and who I will call “Joe”), and out of curiosity, asked how he felt about his retirement readiness. Joe had the same story as Becky; Joe is not covered under his employer’s 401(k) plan, and he has little confidence that he can retire – and certainly not retire comfortably, unless something changes soon.
Unfortunately, the experience and retirement “unreadiness” of Becky and Joe seems far too common. According to an annual survey1 (see the 13th Annual Transamerica Retirement Survey) conducted by the Transamerica Center for Retirement Studies, a nonprofit, private foundation whose mission includes illuminating emerging trends, promoting awareness, and helping educate the public about retirement, 82 percent of for-profit employers with 10 or more employees offer a 401(k) or similar plan; however, only 57 percent of part-time workers said that they have access to a such plan. For all workers (including part-time workers), the survey found that:
- current levels of savings are inadequate for many workers to meet their future retirement income needs;
- 56 percent of workers expect to work past age 65 or do not plan to retire, including 43 percent who plan to work past age 70 or do not plan to retire; and
- 54 percent of workers plan to continue working after they retire.
As a result of these findings, I’m writing this to encourage employers, advisors, and others in the retirement industry to expand retirement plan coverage, such as the ability to participate in a 401(k) plan, to part-time employees, so that more U.S. workers can be better financially prepared at retirement.
Before I provide suggested actions to take, here’s some background regarding the exclusion of part-time employees from 401(k) plans.
As an industry practitioner for more than 20 years, it is no surprise to me that many 401(k) plans exclude part-time employees. I am used to seeing certain classes of employees excluded from employers’ 401(k) plans. Common exclusions include union employees where retirement provisions were the subject of good-faith bargaining, and employees who work on a part-time basis.
Next, I realize the Internal Revenue Code (“Code”) and associated Treasury regulations (“Regulations”) allow exclusions of employees from 401(k) plans, including the statutory exclusion of employees who work less than 1,000 hours during a consecutive twelve-month period. Even for those who work more than 1,000 hours, the Code and Regulations allow employers to exclude named classes of employees, (generally feasible only if an annual nondiscrimination test, commonly referenced as a “coverage” test pursuant to Code section 410(b), is met).
I also realize the reason for excluding employees, such as part-time employees, might be related to perceived or actual plan administrative cost considerations and/or perceived or actual detrimental impact on some of the nondiscrimination tests (such as the Actual Deferral Percentage [“ADP”] test, which compares the average deferral of the highly-paid employees to the average deferral of all other employees in a 401(k) plan).
The end result of the Code and Regulations (allowing employers to exclude certain employees from their 401(k) plans), along with perceptions as to why excluding certain employees from a 401(k) plan might seem necessary, is that many part-time employees are not covered by their employer’s retirement plan. Friends and workers like Becky and Joe will continue to be ill-prepared for retirement – and it doesn’t have to be that way.
As I stated earlier, I’m encouraging employers and their advisors to expand retirement plan coverage to part-time employees. In this regard, here are alternatives on what employees to cover under a 401(k) plan, what plan provisions to provide and why, and why excluding employees could be unnecessary.
Who to cover: Cover all employees, except for perhaps those whose jobs are more temporary in nature, where it is anticipated or expected that employment will last less than a year. Part-time employees who are anticipated or expected to remain in employment for more than a year, even if working less than 1,000 hours each year, can be covered.
Provisions to provide: At a minimum, allow all employees to make pre-tax and after-tax (Roth) contributions to a 401(k) plan. Here are the main benefits of allowing employees to make contributions to a 401(k) plan:
- Pre-tax contributions provide employees with an immediate deferral of current income taxes on the compensation contributed, and the deferral of any tax on investment gains (which can be a great benefit, since over time, investment gains can be quite impressive). The more time the employee is able to save and to let investment gains accumulate, the bigger the retirement nest egg available. Upon withdrawal from the plan (which is hopefully at/after retirement and when the retiree’s income tax bracket presumably is lower post-retirement than before), ordinary income taxes will apply.
- Roth contributions are taxed when made to the plan, but any investment gains are never taxed (provided the first Roth contributions were made at least five years before the first withdrawal and provided the participant is at least age 59 ½ at the time of withdrawal). For younger employees, especially, making Roth contributions versus pre-tax contributions might be more beneficial. Generally, younger employees are in a lower income tax bracket than what will apply as their salaries (and income tax brackets) increase throughout the years. In addition, younger employees’ Roth contributions have a long period of time over which to experience investment gains. The end result is that at the time of withdrawal, the Roth contributions have grown in amount, and no part of the distribution is taxable. By being taxed at a low rate at the time made (years prior to the withdrawal), and by never being taxed on the investment gains, making Roth contributions can prove beneficial to an employee.
- For lower-income employees, making contributions to a 401(k) plan can also allow the employees to take advantage of the Saver’s Credit. For the first $2,000 of contributions an employee makes to a 401(k) or similar employer-sponsored retirement plan (or to an IRA), tax credits are available of up to $1,000 for single-filers, and $2,000 for married couples. For 2013, the adjusted gross income limit for the Saver’s Credit is $59,000 for married couples filing jointly; $44,250 for heads of household; and $29,500 for married individuals filing separately and for singles.
Consider implementing an automatic contribution arrangement (frequently referenced as an automatic enrollment provision or feature). In an automatic contribution arrangement, pre-tax and/or Roth contributions are automatically made to the 401(k) plan, unless the employee affirmatively elects not to make contributions or elects a percentage other than an applicable default percentage.
- Industry surveys by Aon Hewitt and by the Vanguard Group, as referenced in an article in Institutional Investor found that most employees who are automatically enrolled will stay enrolled, meaning the employees will continue allowing contributions made to the 401(k) plan on their behalf.
- In addition, the findings show that employees continue to stay enrolled in an automatic contribution arrangement even where the arrangement has an escalation feature. Typically, an escalation feature is where annually, the default contribution percentage rate at which an employee was automatically enrolled is gradually increased up to a stated ceiling percentage.
ADP test consideration: Ensure the 401(k) plan provides for the “otherwise excludable” rule (under Regulation section 1.401(k)-2(a)(1)(iii)), which allows for what is known as “split-testing.”
Split-testing means just as it reads, which is that the otherwise one ADP test may be split into two ADP tests. One split ADP test includes all eligible employees who are at least age 21 and who have earned at least one year of service (generally, a consecutive twelve-month period during which an employee works at least 1,000 hours), and the other split ADP test includes all other eligible employees. (A variation of split-testing exists under the “early participation” rule also found under the Regulation cited above.)
The “otherwise excludable” rule is designed so that employers with 401(k) plans who provide for more generous coverage than absolutely required (such as covering employees who work less than 1,000 hours during a year) are not penalized for doing so.
For many employers who cover part-time employees, the “otherwise excludable” rule will help ensure the ADP test(s) are not unfavorably affected by allowing the more generous coverage. The split-testing helps diminish the impact of low participation rates, if applicable, by lower-paid employees who work less than 1,000 hours during a year.
Fee considerations: If plan administrative fees are paid by the 401(k) plan, consider ensuring the plan allows forfeitures to pay for plan administrative costs, so any increase in plan costs resulting from expanded coverage might not impact the employer. Where the employer pays plan administrative fees directly, the employer can likely deduct such for purposes of its income tax return.
In addition to the above fee considerations, the higher the amount of a 401(k) plan’s assets, the fees generally tend to decrease – so expanding coverage to more employees could result in more plan balances and greater plan assets, thereby reducing plan expenses.
It’s been heartening to see a concern about, and focus on, U.S. employees’ retirement readiness within the last several years. This has included proposed legislation at the federal and state levels – but we don’t need to depend upon additional legislation. Rather, all of us can act now to help ensure employees’ retirement readiness, simply by expanding coverage to more employees like Becky and Joe, and implementing plan provisions making it easier for employees to save.
1Source: 13th Annual Transamerica Retirement Survey of workers. ©2013. The Transamerica Center for Retirement Studies® is a nonprofit, private foundation and is funded by contributions from Transamerica Life Insurance Company and its affiliates and may receive funds from unaffiliated third-parties. For more information about The Center and a full methodology, please visit www.transamericacenter.org