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RETIREMENT PLAN BASICS FOR EMPLOYERS

In today's ever-changing regulatory environment, an array of qualified retirement programs are available to you and your employees.  Pollard & Associates will meet with you to determine what type of qualified retirement plan best suits your business climate, the characteristics of your employee group and your long-term goals.

Why Consider a Retirement Plan

Qualified retirement plans offer many benefits - for you, your business, and your employees. Qualified plans provide a means to enhance the financial security of participants in retirement, and offer significant tax advantages as well.

Benefits to you and your business include:

  • Employer contributions are tax deductible
  • Employees can elect to participate through 401(k) programs to help them with their retirement savings
  • Assets in the plan grow tax-free
  • Businesses may receive tax credits and other incentives for starting a plan
  • Enhances attraction and retention of valuable employees
Benefits to employees include:
  • Tax on employee contributions is deferred until distributed (traditional 401(k) contributions)
  • Investment gains in the plan grow tax deferred until distributed (traditional 401(k) contributions)
  • Roth 401(k) contributions provide an opportunity to pay tax now on employee contributions and allow for tax-free withdrawals (including investment gains) in retirement
  • Retirement assets in an individual account are portable and can be carried from one employer to another
  • Contributions can be made effortlessly through payroll deductions
  • Saver’s Credit is available to low-income workers
  • Flexible plan options are available (e.g., Roth v. traditional contributions)
  • Better financial security can be attained upon retirement
  • Plan assets cannot be reached by creditors

What Are My Qualified Plan Options

Qualified retirement plans fall into two general categories: defined contribution plans and defined benefit plans. A defined contribution plan, also known as an individual account plan, maintains an account balance for each participant. In these plans, the employee and/or the employer contribute to the employee's individual account and the participant’s benefit is ultimately based on the value of his or her account at retirement. In contrast, a defined benefit plan promises a specified monthly benefit at retirement. Traditional defined benefit plans often define the monthly benefit as a percentage of average salary based on years of service. A traditional defined benefit plan does not maintain individual account balances to reflect the accrued benefits of plan participants, but rather maintains a pooled trust account for the benefit of all plan participants.

 

Defined Benefit
Plans

Defined Contribution
Plans

Retirement benefits

Annual benefit determined by plan’s benefit formula

Benefit based on participant’s account balance at retirement

Benefit payments

Normally annuity payments
Lump sum payments optional

Normally lump sum payment

Contributions (with tax-favored status) made by

Employers only

Employers and /or employees

Employees demographics favored under the plan

Traditionally favors older (45)+ employees and longer-tenured employees

Favors younger, higher-paid, shorter-tenured employees

Annual contribution / funding obligation

Yes

Potentially depending on plan type

Contribution / funding variability and risk

Higher variability & risk
Less predictability

Lower variability & risk
More predictability

Annual contribution (tax deduction) limit

Higher
Amount up to plan’s unfunded target liability

Lower
25% of compensation

Actuarial certification required

Yes

No

Allows for participant loans

Yes

Yes

Allows for participant hardship withdrawals  or other in-service withdrawals

No

Generally Yes

Bears risk of investment losses and benefits from investment gains

Employer

Employees

Provides for employee-directed investments

No

Yes

Administrative complexity

Higher

Lower


Defined contribution plans can be one of several types, each with its own unique characteristics:

  • Profit Sharing Plans provide complete flexibility in determining annual contributions. Despite its name, annual contribution amounts are not tied directly to the profits of the employer.
  • New Comparability or Cross-Tested Plans are a type of profit sharing plan that allow for various levels of contributions for separate classifications of employees, allowing a plan sponsor to favor owners, management, or other select groups.
  • Money Purchase or Target Benefit Plans require an annual contribution amount determined by a fixed formula (fixed percentage of compensation in Money Purchase plan; actuarially determined amount in Target Benefit plan).
  • 401(k) Plans provide for employee pre-tax and/or after-tax (Roth) contributions up to the annual deferral limit and may be combined with profit sharing and/or company matching contributions.
  • 403(b) Plans provide for features similar to 401(k) plans but are available only to certain public schools and tax-exempt employers.
  • Employee Stock Ownership Plans (ESOPs) invest primarily in the stock of the employer company, and can provide for a leveraged buy-out from existing owners.

Hybrid plans – such as cash balance plans – are a cross between traditional defined benefit plans and defined contribution plans. Like traditional pensions, hybrid plans guarantee the amount of an employee's retirement benefit (and are therefore classified as defined benefit plans by government agencies). These benefits, however, are defined as a lump sum account balance—just like a defined contribution plan—rather than a lifetime monthly annuity payment that an employee would receive from a traditional pension. Hybrid plans are funded by the employer, with contributions usually based on factors such as age or years of service. In a typical cash balance plan, a participant's account is credited each year with a pay credit (such as 5 percent of compensation from his or her employer) and an interest credit (either a fixed rate or a variable rate that is linked to an index such as the one-year Treasury bill rate). Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer.