SAN LUIS PENSION CONSULTANTS
 


National Institute of Pension Administrators

ASPPA Member

PLANS
 
Employer Sponsored Plans
Designing the Plan to Meet Company Objectives

   Plan Types
Profit Sharing Plans
401(k) Plans
Money Purchase Pension Plans
Defined Benefit/Cash Balance Plans
 


Employer Sponsored Plans

The Internal Revenue Service provides significant tax incentives to encourage businesses to establish retirement plans. Tax-qualified plans enjoy favorable tax treatment as follows:

  • Tax-deductible contributions to the plan
  • The plan does not pay income taxes on most of its investment earnings
  • Participants are not taxed on their benefits until they receive them

Retirement plans can also help to attract and retain employees. They can have a very positive effect on employees' morale by helping them to save for their future.


Designing the Plan to Meet Company Objectives

Proper plan design can help to minimize costs and provide flexibility in the amount of the annual contribution.

Eligibility Requirements

A plan is not required to cover all employees. Part-time employees (less than 1,000 hrs per year) and employees under age 21 who have worked for less than a year can be excluded. In certain situations employees who have worked less than two years can be excluded if their benefits are fully vested as soon as they enter the plan.

In addition certain employees or classes of employees can be excluded from plan participation regardless of their age or how long they have worked. The extent to which this can be done is limited by law.

Vesting

Plans can have vesting (ownership) schedules that require participants to work a specified number of years before they "own" 100% of their benefit. Participants who terminate before becoming fully vested forfeit the portion of their benefit that is not vested. The forfeited amount is either divided among the remaining participants or used to reduce future employer contributions. Generally the vesting schedule requires six years of employment to become 100% vested.

Plan Types


Profit Sharing Plans

Profit Sharing Plans are the most flexible qualified plan available. An employer can contribute and deduct up to 25% of the eligible employees' total compensation. The maximum amount that can be allocated to any one participant is the lesser of 100% of the participant’s compensation or $52,000. The decision to make a contribution is made by the employer on an annual basis and it is not necessary to make a contribution each year.

Advantages

  • Contributions are discretionary and can vary from year to year.
  • Forfeitures from terminating employees can be reallocated to active plan participants.
  • In certain situations a cross tested allocation method can produce the maximum 100%/$52,000 allocation to an older business owner with a lower allocation rate to non-owner employees.


401(k) Plans

The 401(k) Plan is a profit sharing plan that also allows employees to make contributions with pretax dollars from their pay checks.

The maximum amount that an employee can contribute to a 401(k) Plan in 2014 is $17,500. If a person is age 50 or older, a plan may permit a catch up contribution of $5,500 for 2014.

The amount that highly compensated employees can contribute is limited by the amounts contributed by the nonhighly compensated employees. The law requires the use of nondiscrimination tests to determine the maximum contribution levels for highly compensated employees. If a plan is designed to use a Safe Harbor approach, the discrimination tests are automatically satisfied.

Advantages

  • Under certain situations no employer contributions are required.
  • The employer can make discretionary matching and/or profit sharing contributions.
  • Employee participation is optional.
  • Employees' contributions reduce their taxable income.

Possible Disadvantages

  • Plans must satisfy nondiscrimination tests and if these tests are not passed, corrective action must be taken.
  • Administration and testing can be more complicated than for other kinds of plans.


Money Purchase Pension Plans

Since Profit Sharing Plans now provide the same 25% of compensation deduction limits/$52,000 allocation as a Money Purchase Pension Plan, the mandatory funding requirements associated with a Money Purchase Pension Plan are not as attractive as they once were.



Defined Benefit Plans/Cash Balance Plans

A defined benefit plan promises to pay participants a specified monthly income at retirement. The amount of monthly benefits is usually based upon the participant's compensation and years of service. The maximum amount of annual retirement income is the lesser of the highest consecutive three-year average compensation or $210,000.

Contribution levels are determined by an actuary, based on actuarial assumptions about future pay increases, investment performance, years until retirement and life expectancy after retirement.

Contributions to a Defined Benefit Plan are mandatory and must satisfy minimum standards. Larger contributions must be made on behalf of older participants to fund a specified benefit level because an older participant has fewer years remaining until retirement.

Advantages

  • Contributions for older business owners and key employees can be substantially higher in a defined benefit plan than in other types of retirement plans.
  • Cash Balance Plan can be operated in combination with a 401K plan to provide substantial contributions to business owners and key employees.

Possible Disadvantages

  • The promised benefit must be provided to all participants regardless of the actual investment performance of the plan. Poor investment performance could result in increased contribution amounts from the employer.
  • Termination of a defined benefit plan that is overfunded could result in an excise tax to the employer ranging from 20% to 50% on the amount of excess assets.