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How to start a 401(k) plan for your firm: a guide to establishing a retirement plan for small and emerging firms.

As an entrepreneur, you're probably all too familiar with the soaring costs of employee benefits. In many businesses, "perks" such as health and life insurance tack on an extra 35% to payroll.

Still, there's no getting around it: A strong benefits program is a must. Quality employees are your company's biggest asset, and the best way to attract, retain and motivate top-level employees is to offer a solid savings and retirement plan.

Luckily, there's a way to provide this benefit and lower your costs, as well. The solution: a 401 (k), by far the most popular savings and retirement benefits program. Today, there are more than 100,000 401 (k) programs in the United States, covering 19 million people.

What makes a 401 (k) plan so appealing is its structure. Defined-contribution plans (named for Section 401 (k) of the Internal Revenue Code) let employees earmark a percentage of their wages, before taxes, toward a retirement fund. To enhance the plan's value, most employers match these pretax contributions - normally 50 cents of every dollar, or up to 6% of an employee's salary.

Granted, implementing such a plan will tilt your till a bit, since it may cost anywhere from $8 to $50 a head to administer your 401 (k). But the tab is well worth it. For starters, a 401 (k) is inexpensive compared with traditional pension plans, which are entirely company-sponsored. Besides, the money you funnel toward a 401 (k) is likely to be offset anyway by lowering your staffs turnover rate.

Think you're too small to have a 401 (k) plan? Don't let size fool you. Anyone with more than 10 employees is a good candidate for a 401 (k) plan, says Larry Helmke, vice president with the employee benefits consulting firm of Towers Perrin in Dallas. In fact, about two-thirds of all such plans are provided by firms with fewer than 100 employees.

Gearing up a plan, of course, means you'll have plenty of details to sort out. How will the plan work? Who will run it? How much will you have to do? The answers to these tough questions will come from your staff and the company you hire to handle the plan.

You'll find a host of 401 (k) plan providers - from commercial banks to insurance carriers to mutual fund companies. With so many players in such a small field, you must be very selective, warns Bill Thompson, director of marketing for Fidelity Investments in Florence, Ky.

The first step is to solicit several detailed proposals from prospective plan administrators. Make sure you allow enough time - be it six months or a year - to craft the right plan for your firm. But before we go further, let's look at the basics.

How Will A 401 (k)

Benefit Your Employees?

Everyone loves a tax break. And one of the biggest boons to 401 (k) participants is that they don't pay federal (and, in most cases, state) income tax on their savings. All contributions reduce taxable income dollar-for-dollar and compound tax-deferred until withdrawn.

In 1994, employees may contribute up to $8,994, before taxes to a 401 (k) account. The precise amount rises each year with inflation. The limit for combined employer and employee contributions is 15% of the total compensation of all participants.

You can't overemphasize the importance of having employees set aside a pre-set amount of money each month in a tax-deferred investment that can grow to a significant amount of money over time. Be sure to stress to your employees that for every $100 they invest before taxes, they're getting the equivalent of a taxable investment of as much as $145 if they're in the 31% federal tax bracket. When you consider state and local taxes, the return may be higher for them.

With individual retirement accounts (IRAs) no longer fully deductible, a 401 (k) plan is a great way to get all the benefits of an IRA but with higher contribution limits. The maximum contribution for an IRA is $2,000 for a single individual.

Another benefit: Employees have a say about how their money is invested. Each employee determines how much to contribute and how to divide the money among available investment choices.

How Will A 401 (k) Plan Benefit You?

A 401 (k) helps promote good employer/employee relations by showing that you're concerned about the financial future of your workers. Such a plan also eases the burden of investing your employees' money, a responsibility you'd have with a private pension fund. Employees bear most of the cost of building a retirement account through their own contributions (on average, it is about $3,000 a year per worker).

Moreover, contributions that you, as the employer, make to the plan are tax-deductible. This alone can be a significant reason to establish a plan for your company. Just ask Darwin N. Davis Jr., a registered representative with The Equitable Life Assurance Society in White Plains, N.Y., who helped managers at BLACK ENTERPRISE set up a 401 (k).

"Let's say a business makes a net profit of $1 million. Well, the corporate tax rate is 34% for profits above $335,0001," explains Davis. "But if that company were to put half of the money into its own 401 (k) plan, it would be taxed at 34% only on $500,000." you may decide each year whether or not to make this additional discretionary contribution, and, if so, how much.

Putting A 401 (k) Plan Into Action

Before you set up a 401 (k) plan, assign a staff member as plan administrator. The obvious candidate is your human resources director or whoever coordinates employee benefits. In smaller companies, the chief operating officer handles the duties.

It's important that you find a way to discover what your employees want out of a plan. Do they demand a wide range of investment options? Are they partial to mutual funds? Company, stock? Some companies go so far as to conduct surveys. As a guideline, you'll need to address the following in establishing your plan:

Design your plan. You will be glad to know that the IRS has given you and your advisers - attorney, accountant, benefits director, etc. - a head start in designing a plan. There are preapproved prototype documents that explain clearly what a 401 (k) plan entails (these forms are available at any local IRS office). By filling out these government forms, you'll save up to 90% of the cost of developing a plan document from scratch. The prototype should offer a variety of contribution, retirement-age and vesting options.

It's also important that the plan administrator study firsthand the general makeup of the company in order to tailor a plan that fits its needs, says David Egel, assistant vice president of pensions, Sun Life Assurance Company of Canada in Wellesley Hills, Mass. "So, if your company has 60 people, and most of them are in their 50s, you aren't offering a plan with a bunch of aggressive investment options."

Find a fund administrator. Your plan administrator (or trustee) should also help investigate and select a pension fund administrator. This is the firm that will help you collect data from your workforce to determine employee eligibility, as well as handle all contributions and investment earnings. An administrator should also take care of the recordkeeping and accounting, prepare employee and management statements and file all IRS reports - keeping your plan in compliance with federal and state regulations.

A warning: Don't go with the first snazzy fund manager who walks through the door. There are some fundamental things to look for when choosing a fund administrator, suggests Fidelity Investments' Bill Thompson. For instance, does the company have a demonstrated track record in investment management? How many plans do they have under management? How well do they understand compliance issues? What support services, such as an 800 number, do they offer? In addition, it may be wise to speak with several clients whose needs match those of your own firm.

Verle B. Hammond was banking on experience when he chose the Washington Group, an independent brokerage house, to handle the top-down design of his company's 401 (k) plan. "I was more than satisfied with this company, since it had been handling my family's investments for years," says the CEO and founder o.f Innovative Logistics Techniques Inc. (INNOLOG), a McLean, Va., firm that specializes in creating electronic inventory control systems for the Army.

The Washington Group didn't go it alone, though. It selected a mutual fund company, The American Funds Group, to provide various fund options and to manage the assets. And a third company was brought in to handle administrative duties. INNOLOG pays only one fee, however, which is shared evenly among the three firms. Since the plan's creation four years ago, INNOLOG has had 108 employees, a 76% participation rate, in the plan.

To play it safe, if your company is leaning toward an insurance carrier to handle the plan, check such rating services as A.M. Best Co. Inc., Moody's Investors Services Inc. or Weiss Research. If you opt to go with an investment company, make sure you are comfortable with the available investments. out of 35 funds, you may be privy to only five of them.

Another word to the wise: Scrutinize closely any amendment costs or withdrawal fees. How much is it going to cost you to change the plan or switch funds from one company to another? Your company may get nicked by as much as 6%.

"Many small companies often fail to know exactly what they're paying for," adds Thompson. Yes, some of the language may be murky, but it's in your best interest to understand where every dime is going and why.

Select a range of investment options. Some of your employees will want their retirement money to be as safe as possible. Others will accept some volatility in pursuit of higher returns. Your plan should accommodate both, offering enough choices to match all employees' needs and investment objectives.

Seek out a high-quality family, or families, of growth, income and balanced combination of stocks and bonds) funds. Some employees may also want a fixed-rate option, which typically can be satisfied by including a fixed annuity product in your plan. A more sophisticated plan offers individual stock, bonds and even real estate investment trusts (REITS).

Under the new provisions of ERISA (Section 404C), participants must be able to choose from at least three diverse investment alternatives, transfer money between funds at least once every three months and receive sufficient information from their employers to make sound investment decisions.

Certainly, pension fund managers who choose to comply with the rule shouldn't be held liable for participants' bad picks. Still, as manager, you have a fiduciary obligation to offer reasonable investments. Whatever products you offer, make sure they are under solid investment management and can be easily tracked in local newspapers,

Determine matching contributions. At a minimum, you should plan to match at least 20 cents on the dollar, up to 4% of an employee's pay. If you aren't going to make the plan enticing, then what's the point?

Needless to say, finding the funds to match employee contributions is an ongoing challenge, says Susan Jones, manager of compensation and benefits at Maxima Corp. in Lanham, Md. "The money can be justified either from profits or assets like any other expense."

The 15-year-old systems engineering firm (No. 25 on the BE INDUSTRIAL SERVICE 100s) has 755 employees, with more than 50% of them participating in the company's 401 (k) plan.

No matter how popular you predict your plan will be, be very realistic about the amount of money you can afford to match. Once you make the commitment, it's set in stone.

Get people to enroll. It's important to get plenty of people enrolled in your plan. Provide a simple document that makes it easy for employees to participate. Don't forget to include effective marketing-payroll stuffers, posters, communications in your company newsletter, formal meetings and maybe even a videotape to help your employees and their families understand this important benefit.

Poor enrollment may be the kiss of death for your program. While the number of employees eligible to participate is more than 40 million today, less than half of those workers participate primarily for this reason.

"If the program is explained well and there's a general level of excitement [with the employer matching the program], then we see participation rates at 92%," says Towers Perrin's Larry Helmke.

Thanks to year-round educational sessions, Earl G. Graves Ltd., publisher of BLACK ENTERPRISE magazine, has a 90% participation rate. "Twice a year, we bring in outside experts - accountants, financial planners, etc. - to talk to employees about the plan and their investment options," says Luther M. Ragin Jr., chief financial officer.

If employees aren't well educated about the plan's features and types of investments, an employer may end up spending more time trying to fix problems.

Also, what else are you willing to give up? About two-thirds of companies with 401 (k) plans, for example, provide loan provisions or hardship withdrawals. "Our plan is also flexible in that it has a loan provision and is very generous in that it matches employee contributions dollar for dollar, [compared with the typical 50 cents offered by companies that are larger in size]," Ragin says.

Despite these obvious, benefits, 401 (k) plans can be intimidating to companies that haven't pursued this benefit for their employees. But it doesn't have to be that way. Simply make sure to seek the help of competent financial and legal advisers.

Keep in mind: What's nice about a 401 (k) is that it gives you a format vehicle to share profits with employees. And it's reward that your workers can truly - and literally - appreciate.
COPYRIGHT 1994 Earl G. Graves Publishing Co., Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1994, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:McBride, John
Publication:Black Enterprise
Date:Mar 1, 1994
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