Types Of Plans
Saving for retirement is essential for all individuals, no matter their age. There are numerous types of pension plans individuals can adopt that do not require administration. However, contributions in individual plans are limited. Our role is to help clients maximize retirement savings by strategizing their goals for the company and its employees under the employer sponsored plans. All employer sponsored retirement plan benefits are protected from creditors. There are different approaches for maximizing contributions and tax savings depending on the type of legal entity. Our team of consultants is readily available to guide you in selecting a pension plan that best aligns with your unique needs.
40l(k) PLAN:
A 40I(k) plan is the most widely known type of retirement plan. It helps promote financial security and reduces the dependency solely on social security benefits for retirement. It is administratively cost effective for the employer and helps employees save for their financial future. This plan helps employees save a portion of their salary up to the dollar limits and an additional catch-up amount for employees over the age of 50. The 40I(k) contribution limits are set by the Internal Revenue Service (IRS) annually.
Employees can elect to contribute before-tax or after-tax. “The pre-tax dollars are tax deferred until withdrawal. The adjusted gross income (ACI) is reduced by the amount deposited into the 40I(k), which helps reduce the taxable income, and, consequently, reduces the tax liability for individuals. Under this plan, the employees have the flexibility to invest as aggressively as desired to maximize savings. However, at the time of withdrawal, the benefits are taxable and subject to penalties before the age of 59
Employees also have the option to make contributions to a Roth 40I(k) with after-tax dollars. “the taxable income in this case is not impacted. “The limits for Roth contributions are similar to pre-tax contributions. While contributions to a Roth 40I(k) do not provide an immediate tax advantage, at the time of withdrawal the principal plus the earnings are tax free. Additionally, unlike pre-tax contributions, Roth contributions do not have required minimum distributions during the account holder’s lifetime. Similar to traditional 40I(k), employees under the age of 59 ½ are subject to the early withdrawal penalties
Safe Harbor Plan:
In addition to 40I(k) contributions, employers like to incentivize their employees by adding Safe Harbor employer contributions. Traditional 40I(k) plans are subject to annual non-discrimination testing to ensure that benefits are not disproportionately favoring highly compensated employees. A safe harbor contribution satisfies this testing requirement and, therefore, is exempt from ADP/ACP non-discrimination testing, which allows the plan to avoid certain contribution restrictions for owners and highly compensated employees.
Depending on the employee demographics and budget, a safe harbor option is selected from the various types of safe harbor contributions available. The two most widely used safe harbor options are: the 3% Safe Harbor Non-Elective, which is provided to all employees, irrespective of their participation in the 40l(k). The other is a Safe Harbor Match, , where the employer matches dollar-for-dollar deferral up to 4% of salary. In a competitive job market, employers may use a Safe Harbor contribution as part of their benefits package to stand out among competitors. A generous retirement plan with a Safe Harbor feature can be a valuable recruitment tool and an attractive incentive for retaining existing top talent employees.
Profit Sharing or Defined Contribution Plan:
To further incentivize the employees, employers can provide an additional discretionary contribution. The company’s contribution cannot exceed 25% of the total compensation of all eligible employees. The IRS also has annual contribution limits for this plan. Profit-sharing plans are inherently performance-based. Employees receive a share of the profits based on the company’s financial performance, rewarding their collective efforts in contributing to the company’s success. The employer’s contributions to this plan are subject to a vesting schedule, ensuring that employees gain ownership over these contributions based on their years of service in the company.
This benefits both the employers and the employees to maintain a stable and committed workforce. Contributions to the profit sharing plan are generally pre-tax and tax deferred to employees. Employers benefit by taking a tax deduction of all contributions provided to the employees to reduce the corporate tax liability.
Defined Benefit Pension Plan:
A defined benefit pension plan is an employer-sponsored retirement plan that is highly beneficial to majority owners and key executive employees. The lump sum at retirement is calculated by the actuarial based on many factors, such as three consecutive years of high salary, number of years until retirement, length of employment, actuarial interest rates, and 415 limits set by the IRS to name a few,. Based on the lump sum at retirement, reverse engineering is used to calculate the range of contributions each year. The contribution range under the Defined benefit plan is huge, providing higher tax savings and faster accumulation of assets.
Typically, these plans are fully funded by the employer, making them responsible for contributing sufficient funds to fulfill the promised benefits, irrespective of the company’s profitability or earnings. It’s important to emphasize that employer contributions to meet the plan’s obligations are mandatory and may fluctuate due to gains or losses in plan investment strategies. Therefore, the actuary’s role is crucial in managing investment risk, interest rate risk, and longevity risk to ensure that the plan is sufficiently funded each year within the guidelines of the IRS. All defined benefit plan contributions are tax deducted on the corporate tax return.
Floor Offset Plan:
A floor offset plan is a combination of a Defined Benefit and a Profit-Sharing plan. The company can also attach a safe harbor 40I(k) option to maximize benefits for both the owners and employees. This type of plan is more suitable for owners who are closer to retirement and employees who have many more years until retirement. ‘These two plans are cross-tested to satisfy minimum coverage and non-discrimination testing according to the guidelines of the IRS. Both plans provide flexibility to all participants in the plan to invest as per their individual risk tolerance.
Typically, owners of the company and key executive employees receive a benefit under the Defined Benefit plan and employees receive benefits under the Profit-Sharing plan. Under the Defined Benefit plan, employers can maximize their contributions and significantly reduce their corporate tax liability with huge annual contributions from the employer’s company profits. Alternatively, employers’ contribution to the employees provides at least 5% of the salary to all eligible employees which is also tax deductible at the corporate level.
This combination plan attracts employees as the 40I(k) contribution is made from the employee’s paycheck. This contribution is fully vested and helps reduce employee’s salary and individual tax liability. The Safe Harbor employer contributions are also fully vested, which guarantees some financial savings for retirement. Additionally, the Profit-Sharing contributions are on a vesting schedule to encourage employees to work for a longer period in the company. This is also beneficial to the owner for retaining and incentivizing employees that work harder.