Plans We Support
The Pension Source supports qualified retirement plans. A plan is “qualified” when it meets a specific set of requirements established by the IRS that dictate minimum coverage, vesting and funding requirements. Once qualified, a retirement plan and the adopting employer then receives specific tax advantages, including:
Tax deductible employer contributions
Tax-deferred earnings on investments, which allow contributions and earnings to compound at a faster rate
Untaxed contributions and earnings for employees prior to retirement
Tax deductions for ongoing plan expenses
Pre-tax contributions for employees in certain types of plans
A qualified retirement plan can also help an employer attract, retain and motivate good employees. And an employee’s plan assets are protected from creditors, whether of the employer or employee.
Employers can choose one of two general types of retirement plans: Defined Contribution or Defined Benefit. Our consultants can help you determine which type of plan will best serve your personal goals and those of your business.
Defined Contribution Plan
In a Defined Contribution or DC plan, the contribution an employer makes to the plan is defined, as is the way in which that contribution will be allocated among eligible employees. The plan maintains individual account balances for each employee, and these accounts grow through employer contributions, investment earnings and, in some cases, forfeitures (amounts from the non-vested accounts of terminated participants). Some plans may also permit employees to make contributions on a before- and/or after-tax basis.
In a DC plan, contributions, investment results and forfeiture allocations vary year-by-year. As a result, the future retirement benefit for each participating employee cannot be predicted. The employee’s retirement, death or disability benefit is based upon the amount in his or her account at the time the distribution is payable.
Profit Sharing Plan
In general terms, a Profit Sharing plan is 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 employees 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.
More and more employees view a 401(k) plan as a valuable benefit, making them the most popular retirement plan in the market today. 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. The plan may also permit employees age 50 and older to make additional 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. 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 also 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, 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.
401(k) Safe Harbor Plan
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 that 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.
Defined Benefit Plan
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 employees 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) 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.
Cash Balance Plan
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 employees benefit is expressed as a hypothetical account balance instead of a monthly benefit, making it look like a Defined Contribution plan.
Each employees 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.
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 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 is 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.