Why Should You Set Up an Employee Retirement Plan, and What are Some of the Benefits?
A retirement plan has lots of benefits - for you, your business, and your employees. Retirement plans allow investing in the future now for financial security when you and your employees retire. As a bonus, you and your employees get significant tax advantages and other incentives.
Employer contributions are tax deductible.
Retirement assets in the plan grow tax-free.
Investments grow with compounding interest.
Businesses may receive tax credits and other incentives for starting a plan.
A competitive advantage in attracting and retaining employees, consequently reducing new employee training costs.
Tax on employee contributions is deferred until distributed.
Investment gains in the plan are not taxed until distributed.
Retirement assets can be carried from one employer to another.
Contributions can be made easily through payroll deductions.
Saver’s Credit is available.
Flexible plan options are available.
Better financial security is available upon retirement.
There are multiple types of qualified retirement plans that can meet your needs as a business owner. Below is more information on the different types of retirement plans available. We can help you choose the plan which is best for your specific needs.
401(k) plans are the most popular type of retirement plan used today. They can be a powerful tool in promoting financial security in retirement and are a valuable option for businesses considering a retirement plan. Businesses that should consider establishing a 401(k) plan are organizations that would like a retirement plan where the employee shares the responsibility for their retirement.
A section 401(k) plan is a type of tax-qualified deferred compensation plan in which an employee can elect to contribute a portion of his or her cash wages to the plan on a pretax basis. There is a maximum limit on the total yearly employee pretax salary deferral (commonly referred to as elective deferrals). The 2009 limit is $16,500 and will remain the same for 2010. For future years, the limit may be indexed for inflation. The plan may also permit employees age 50 and older to make additional “catch-up” contributions. These contributions are also indexed for inflation ($5,500 in 2009).
In addition, employers have the option of making contributions on behalf of all participants, making matching contributions based on employees’ elective deferrals, or both. These employer contributions can be subject to a vesting schedule which provides that an employee’s right to employer contributions becomes nonforfeitable only after a period of time. Rules relating to traditional 401(k) plans require that contributions made under the plan meet specific nondiscrimination requirements. In order to ensure that the plan satisfies these requirements, the employer must perform annual tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, to verify that deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees.
Safe harbor 401(k) plans
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees. In return for providing these fully vested contributions, the safe harbor 401(k) plan is not subject to the complex annual nondiscrimination tests.
A profit sharing plan was originally established as a means for a business to share profits with its employees. Today, the plan is not tied to profits, and may, in fact, make a contribution even if the business is not showing any profit. The contributions to the plan are discretionary and may be determined at the year end when the business owner has met with his or her financial advisor. Businesses of any size can establish a profit sharing plan.
Profit sharing plan rules permit an employer to make tax deductible contributions each year which cannot exceed 25% of the total compensation of all eligible employees or $49,000 per employee (as adjusted for inflation), whichever is less.
Which businesses should consider a profit sharing plan?
Businesses that require a more flexible contribution as employer contributions are strictly discretionary
Businesses where cash flow might be an issue
Businesses that are seeking a deduction for the amount they contribute to the plan, but are not looking for a plan that allows employee contributions
Money Purchase Plan
A money purchase plan is very similar to a profit sharing plan, although a money purchase plan has a fixed contribution requirement that the business determines when the plan begins. The business must then make that same contribution percentage each year for all employees, regardless of profitability.
Defined Benefit Pension Plan
A defined benefit plan is designed to provide a specific benefit amount at retirement. With this traditional pension plan, the business bears the full responsibility of providing the promised level of retirement benefits to participant employees. The benefit amount is generally a predefined annual retirement income for employees.
Contributions to a defined benefit plan are based on what is necessary to provide the promised benefits to plan participants. Actuarial assumptions and computations are required to determine annual contributions, and continued actuarial help is required to maintain a defined benefit plan and to certify benefits and contribution levels. The annual deposits required for older employees, who are closer to retirement, are generally higher than for younger employees, who have a longer time period in which to fund their benefits.
Annual contributions for an employee can greatly exceed the $49,000 maximum found under other plan designs.
Which businesses should consider a defined benefit plan?
- Small closely held businesses that would like to contribute as much as possible to their retirement plan
- Businesses that can commit to an annual contribution
- Businesses whose key employees are nearing retirement
Cash Balance Plan
A cash balance plan is a defined benefit pension plan that incorporates some features of a profit sharing plan. As a defined benefit plan, the plan must follow the rules of a pension plan, including having an actuarial valuation where the benefits and contributions are certified by an actuary. However, a participant sees an account balance projected with contributions and income. Cash balance plans combine the maximum benefits of a defined benefit plan, consequently higher contribution levels, with the portability of a profit sharing plan.
Each plan participant has a hypothetical account which will grow through a company contribution and an interest credit, which is guaranteed and not dependent on the plan’s investment performance. The interest credited is either a fixed rate (for example, 5%) or tied to an index, such as the 30-year Treasury bond rate. Thus, the company rather than the employee bears the investment risk.
Advantages of a cash balance plan include:
Larger tax deductible contributions, based on defined benefit regulations, than a profit sharing or 401(k) Plan.
Acceleration of retirement savings for older key employees, by means of higher contributions.
Easy for plan participants to understand since benefits are communicated in terms of an account balance.
A more predictable cost than a traditional defined benefit pension plan.