Your Expert Guide
Retirement planning is about much more than 401(k). There are many types of retirement plans and with each, many different plan design options. The key to success is a good fit.
To accomplish that, we spend the necessary time to learn about your business, your team, your tax situation, and your goals and aspirations.
Only then will we make recommendations for the right plan type and design to fit your needs.
Getting it right = delivering more
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The 401(k) plan is the most popular retirement plan. Employees can benefit from a 401(k) plan even if the employer makes no contribution by voluntarily electing to make pre-tax contributions through payroll deductions up to an annual maximum limit. Employees age 50 and older can make additional contributions called Catch-up contributions, up to an annual maximum limit. Employee contributions are 100% vested at all times.
A 401(k) plan may also permit employees to make after-tax Roth contributions through payroll deductions instead of pre-tax contributions (or make both). Roth contributions allow an employee to receive a tax-free distribution of the contributions and the earnings on the employees’ Roth contributions if the distribution meets certain requirements.
Additionally, many employers who sponsor a 401(k) plan choose to match some portion of the amount deferred by the employee to encourage greater employee participation. Since a 401(k) plan is a type of Profit Sharing plan, employer profit sharing contributions may be made in addition to, or instead of, matching contributions. Many employers offer employees the opportunity to take hardship withdrawals or to borrow from the plan.
Employee and employer matching contributions are subject to special nondiscrimination tests that limit the amount highly compensated employees (as defined by federal regulations) can defer based on the amounts deferred by non-highly compensated employees.
Safe Harbor 401(k)
A Safe Harbor 401(k) plan incorporates specific provisions in the plan design that require certain levels of employer contributions to non-highly compensated employees. These requirements specify minimum employer contributions and 100% vesting of these contributions. By doing so, the plan can eliminate annual nondiscrimination testing. Elimination of nondiscrimination testing means that the highly compensated employees (typically the business owner(s) and more senior employees) can defer up to the annual limit regardless of the amount deferred by non-highly compensated employees.
As the name implies, a Solo 401(k) is a plan which covers just one business owner who has no employees. A Solo 401(k) plan may also cover the business owner’s spouse. While the requirements are the same as any other 401(k) plan, the amount and methodology to determine annual contribution limits is different and requires special care. Also, since there are no employees, the annual nondiscrimination testing does not apply.
A Profit Sharing plan is generally the most flexible qualified plan available. Company contributions to a Profit Sharing plan are usually made on a discretionary basis. Each year, the employer determines the amount, if any, to be contributed to the plan. The contribution is usually allocated to employees in proportion to compensation. The contribution may also be allocated using a formula that factors in the amount the employer contributes to Social Security on behalf of each employee. This is called Social Security Integration or Permitted Disparity and typically results in larger contributions for the business owner(s) and employees who receive higher compensation.
Amounts contributed to this kind of plan accumulate tax free and are distributed to participants at retirement, after a fixed number of years, or upon the occurrence of a specific event such as disability, death, or termination of employment.
Age-Weighted Profit Sharing
Profit Sharing plans may also use an Age-Weighted allocation formula that takes into account each employee’s age and compensation rate. This formula results in a significantly larger allocation of the contribution to eligible employees who are closer to retirement age. Age-Weighted Profit Sharing plans combine the flexibility of a Profit Sharing plan with the ability of a pension plan to benefit older employees.
New Comparability or Cross-Tested
Sometimes referred to as a cross-tested plan, a New Comparability plan is usually a Profit Sharing plan that is tested for nondiscrimination as though it was a Defined Benefit plan. As a result, certain employees receive much higher contribution allocations than what would normally be permitted by standard nondiscrimination testing. If it fits the overall company strategy, some business owners may find that using a new comparability contribution allocation can maximize contributions for owners and other higher-paid employees while minimizing contributions for all other eligible employees.
A Defined Benefit (DB) plan promises participants a specified monthly benefit, payable at the retirement age specified in the plan. DB plans are usually funded entirely by the employer, who is responsible for contributing enough funds to the plan each year to pay the promised future employee retirement benefits, regardless of company annual profits and earnings.
Employers who want to shelter more than the annual Defined Contribution limit may want to consider a DB plan because contributions can be substantially higher, resulting in faster accumulation of retirement funds.
DB plans use a formula to determine the fixed monthly retirement benefit for each employee. Benefits are usually based on an employee’s compensation and years of service, thus rewarding long(er)-term employees. Benefits may be integrated with Social Security, which reduces the plan’s benefit payments based upon the employee’s Social Security benefit. The maximum benefit allowable is 100% of compensation (based on the highest consecutive three-year average) up to an indexed maximum annual benefit. A Defined Benefit plan may permit employees to elect to receive the benefit in a form other than monthly benefits, such as a lump sum payment.
An actuary determines annual employer contributions based on each employee’s projected retirement benefit and assumptions about investment performance, years until retirement, employee turnover and life expectancy at retirement. Employer contributions to fund the promised benefits are mandatory. Investment gains and losses cause future annual employer contributions to decrease or increase. Non-vested accrued benefits forfeited by terminating employees are used to reduce employer contributions.
A Cash Balance plan is a type of Defined Benefit plan that resembles a Defined Contribution plan. A traditional Defined Benefit plan promises a fixed monthly benefit at retirement that is usually based on compensation and years of service. In a Cash Balance plan, the employee’s benefit is expressed as a hypothetical account balance instead of a monthly benefit, making it look like a Defined Contribution plan.
Each employee’s “account” receives an annual contribution credit, usually a percentage of compensation, and an interest credit based on a guaranteed fixed rate or a recognized index, such as the 30-year U.S. Treasury bond rate, which could vary. This interest credit rate is specified in the plan document. At retirement, the employee’s benefit is equal to the hypothetical account balance, which represents the sum of all contributions and interest credits. Although the plan is required to offer the employee the option of using the “account balance” to purchase an annuity benefit, most employees roll the balance into an individual retirement account (IRA).
In a Cash Balance plan, the employer bears the same investment risks and rewards that come with a traditional Defined Benefit plan. An actuary determines the annual contribution amount, which is the sum of contribution credits for all employees plus the amortization of the difference between the guaranteed interest credits and the actual investment earnings (or losses).
Employees appreciate this plan design because their “accounts” grow year-over-year; yet are protected against fluctuations in the market. In addition, a Cash Balance plan can be more portable than a traditional Defined Benefit plan because most plans permit an employee to roll their cash balances into an IRA at termination or retirement.
Money Purchase Pension
A Money Purchase Pension plan is like a Profit Sharing plan in that all contributions made to the plan are made by the employer. However, unlike a Profit Sharing plan, these contributions are mandatory, not discretionary. A Money Purchase Pension plan requires the employer to make an annual contribution based on a specific formula, such as a percentage of total compensation paid to all employees. It is this characteristic that gives this plan type the “pension plan” label.
403(b) plans are designed to serve nonprofit businesses in much the same way that 401(k) plans serve for-profit businesses. Many of our nonprofit clients find that a 403(b) plan helps them attract and retain good employees. As in a 401(k), each participating employee can elect to make pre-tax or Roth contributions through payroll deductions. And most employers, wanting to provide an added benefit and encourage employee participation, can match a predetermined amount of an employee’s contribution. While most 403(b) plans do include employee and the employer contributions, the employer is not required to make contributions.