Qualified Retirement Plans

Qualified Retirement Plans

Providing a Qualified Retirement Plan is another great way to attract, retain and reward high quality employees. For many small business, a well-designed and managed employee sponsored retirement plan with a high rate of participation by employees can enable the owners to contribute the maximum annual amount toward their own retirement, far more than they could contribute to an IRA. Qualified plans may be either a defined-benefit plan or a defined-contribution plan, and each has specific benefits for both employers and employees.

Benefits for employers include:

Employers may receive a tax deduction for plan contributions.
Employers are able to attract and retain high-quality employees. A qualified plan may be the tiebreaker that wins over a skilled person who is offered relatively similar compensation packages from different potential employers.
Employers may be able to claim a tax credit for part of the ordinary and necessary costs of starting up the plan.. With a maximum of $500 per year for each of the first three years of the plan, the credit equals 50% of the cost to set up the plan, administer it and educate employees about it.

Benefits for employees include:

Employees are provided with some guarantee that their retirement years will be financially secure.
For plans that provide salary-deferral features, employees are able to defer paying taxes on a portion of their compensation until their retirement years, when their tax bracket may be lower.
Some plans allow employees to borrow from the plan. The interest paid on the loan amount is credited to the employee's account, unlike interest on loans obtained from financial institutions, which is paid to the financial institution.

Defined-Benefit Plans

Under a defined-benefit plan, employees' retirement benefits are predetermined by their compensation, years of service and age. For example, the plan may determine that upon retirement an employee will receive 1% of his or her average salary for the last five years of employment for every year of service with the employer. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement.

The employer will make contributions that, based on actuarial assumptions including projected growth of investments, are required to reach the predetermined retirement benefit. Should the performance of plan investments fall below the projected amount, the employer is required to make additional contributions to make up for the shortfall.

The contribution limits for defined-benefit plans are significantly higher than the limits of defined-contribution plans, which makes them ideal vehicle to help high-income self-employed individuals save more money for retirement in the shortest amount of time. However, due to strict rules, requirements and the risk of underfunding due to adverse business conditions, these plans are becoming increasingly rare.

Defined-Contribution Plans

Defined-contribution plans do not promise a specific amount of benefit at retirement. Employees or employers (or both) contribute to these plans. Typically, the contribution will be a percentage of compensation up to a certain dollar amount. Depending on the plan type, the contributions made by the employer may be mandatory or discretionary. The contributions are invested on the employee's behalf, and the benefits paid to employees are based on contributions and any earnings or losses. For defined-contribution plans, employers are not required to make up for any losses on investments. Defined-Contribution Plans include the following plans.

Profit-Sharing or Stock-Bonus Plans

A profit-sharing plan is typically used for sharing profits from the business with employees, but an employer may make profit-sharing contributions regardless of whether the business had profits for the year. Contributions to the plan are usually discretionary, which means that the employer may choose not to contribute to the plan every year. Despite this flexibility, however, the employer must take care not to allow too many consecutive years to pass before contributions are made. The IRS does not specify how many consecutive years are unacceptable but does indicate that contributions to the plan must be substantial and recurring.

A stock-bonus plan is a type of profit sharing by which a corporation uses its own stock to make contributions and distributions. These plans, however, are not available to sole proprietorship's and partnerships.

A profit-sharing and stock-bonus plan may include a 401(k) plan feature.

Profit-sharing and stock-bonus plans are suited for employers who are newly established and are unable to determine profit patterns or who want to have flexibility with making plan contributions.

Money-Purchase Pension Plan

In general, an employer has more flexibility in contributing to a profit-sharing plan than to a money-purchase pension plan. Contributions to a money-purchase pension plan are fixed and are not based on business profits. For example, if according to the plan each participant will receive 10% of eligible compensation, each eligible employee must receive the contribution without regard to the employer's profits for the year.

A money-purchase pension plan is suited for employers who are able to determine profit trends and do not mind being mandated to make contributions to the plan each year.

401(k) Profit-Sharing Plan

A 401(k) plan is a qualified plan that allows employees to defer receiving compensation in order to have the amount contributed to the plan. This arrangement is commonly referred to as a cash or deferred arrangement (CODA). Contributions deferred by employees are referred to as elective deferrals, which are typically made to the 401(k) plan on a pretax basis. An employer may choose to have a stand-alone 401(k) plan or a profit-sharing plan with a 401(k) feature. The employer may also choose to make matching, non-selective or profit-sharing contributions to the plan. A 401(k) plan is suited for an employer who wants employees to assist with funding the plan. (For more insight, read The 4-1-1 On 401(k)s.)

Age-Weighted Plans

An employer may add an age-weighted feature, which allocates a higher percentage of plan contributions to older employees. The assumption is that older employees have less time before they retire and therefore less time to accumulate retirement savings. Age-weighted plans are suitable for business owners who are considerably older than their employees and who may not have had the opportunity to accumulate retirement savings in their earlier years.

Employee Stock Ownership Plans (ESOP's)

Employee stock ownership plans (ESOP's) are a form of defined-contribution plan in which the investments are primarily in the employer's stock. Congress authorized the creation of ESOP's as one method of encouraging employee participation in corporate ownership.

How We Can Help You

Our firm can help you select and/or design the most cost-effective retirement plan for your specific needs and objectives. We'll also help you maximize employee participation, ensure your plan's compliance with ERISA rules and regulations, and minimize your company's liability. In addition, we specialize in helping small business owners maximize the return on their personal investments inside their company retirement plan while, at the same time, reducing their fees and expenses.