There are an array of qualified retirement programs available to Plan Sponsors and their employees. Pollard & Associates is happy to consult with Plan Sponsors and their Financial Advisors to help determine what type of qualified retirement plan best suits their objectives, budget, and long-term financial goals.
Why Consider a Retirement Plan
Qualified retirement plans offer many benefits for both business owners and their employees. Qualified plans provide a means to realize tax advantages for businesses and their owners, as well as a vehicle to enhance the financial retirement security of plan participants.
Benefits to Employer:
- Employer contributions made to the plan are tax deductible to the business (or to the owners/partners if self-employed)
- Employees can elect to participate through 401(k) payroll deduction to allow them to save for retirement
- Businesses are eligible for tax credits for start-up and administrative costs for the first 3 years of a new plan
- Retirement benefits enhance attraction and retention of valuable employees
Benefits to Employees:
- Tax on pre-tax 401(k) contributions is deferred until distributed
- Investment gains on pre-tax 401(k) and Employer contributions grow tax deferred until distributed
- 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 or rolled over into an IRA
- Contributions are made efficiently through payroll deductions
- Saver’s Credit is available to low-income workers
- Facilitates financial security for participants upon retirement
- Plan assets are creditor-proof
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.
Cash balance plans are a cross between traditional defined benefit plans and defined contribution plans. Like traditional pensions, Cash Balance plans guarantee the amount of an employee’s retirement benefit (and are therefore classified as defined benefit plans under ERISA). 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 a percentage of annual compensation. In a typical cash balance plan, a participant’s account is credited each year with a pay credit (such as 3 percent of compensation from his or her employer) and an interest credit (typically a fixed rate of 4% or 5%). 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.
|Defined Benefit / Cash Balance Plans
|Defined Contribution Plans
|Annual benefit determined by plan’s benefit formula (DBP)
Lump sum accumulation of pay credits and interest credits (CBP)
|Benefit based on participant’s account balance at retirement
|Must offer annuity payments
Typically offer lump sum payments as well
|Normally lump sum payment
|Contributions (with tax-favored status) made by
|Employers and/or Employees
|Annual Contribution / Funding Obligation
|Yes, determined by actuarial valuation
|Generally discretionary, unless guaranteed in a Money Purchase Plan
|Contribution / Funding Variability and Risk
|Funding Risk is on Employer
|Benefit Risk is on Employees
|Annual Contribution (tax deduction) Limit
|Best for higher funding goals
Amounts up to plan’s unfunded target ability
|Ideal for lower or variable funding goals
25% of eligible compensation for covered employees
|Actuarial Certification Required
|Allows for Participant Loans
|Allows for Participant Hardship Withdrawals or Other In-Service Withdrawals
|Bears Risk of Investment Losses and Benefits from Investment Gains
|Provides for Employee-Directed Investments
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, unless compliance testing requires minimum amounts for non-key or non-highly compensated participants. 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 defined contribution 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 education organizations 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.