Education and 401(k) participation

Employers who sponsor qualified retirement plans are always looking for ways to boost employee participation in the plan. Many studies have shown that companies can raise participation rates by increasing the company’s matching contribution. However, some of the latest studies show that certain types of employee education may increase participation rates nearly as effectively as matching contributions and at a much lower cost.

Why do employers need to increase participation? For a 401(k) plan to maintain its tax-qualified status, the plan must satisfy certain tax law requirements. One of them is that the plan can not discriminate in favor of highly compensated employees. Highly compensated employees are those employees who were paid more than $105,000 in the past year or own more than a 5 percent interest in the employer. Many employers need to increase the participation rates of their non-highly compensated employees so that their qualified plans will pass a special nondiscrimination test that must be performed each year.

Several recent studies show that targeted communications can be as effective as an increased company matching contribution in boosting plan participation. Targeted communications include generic newsletters and statements prepared by consulting firms or investment managers that discuss current financial market trends, personal investment strategies and the economic outlook.

Communication materials that are tailored to the company’s plan that give more information about the specific plan and suggest appropriate savings levels are also considered targeted communications.

The studies show that employee education can not only increase participation rates, but also may increase the amount employees contribute to the plan and change the way in which participants invest their plan account.

One study revealed that employees who receive targeted 401(k) communications save 2 percent of pay more than those who don’t receive targeted communications. Another survey showed that participants are investing more aggressively and that the change in participant investment allocations can be attributed in part to education programs.

This is good news for employers. If your company can’t afford to offer a high match rate, you might be able to achieve the same results by providing education about investment and savings principles to your employees at a considerably lower cost. The education may boost your plan enrollment rates while helping employees make the most of the retirement plan.

Donald E. Sommese, a certified financial planner, works in the Nashua office of Morgan Stanley. He can be reached at 603-881-3300.