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401(k) plans offer unique advantages, both for you and your employees. Employees like 401(k) plans because they can use pre-tax dollars to grow a retirement nest egg, while usually retaining control over investment decisions. Employers like them because employees share in the cost of providing retirement benefits and because the plans allow for flexibility in how the employer may participate. Profit sharing contributions and matching amounts may be contributed and play a role in encouraging and rewarding employee participation.
At a Glance: 401(k) Plans
- Provide a visible, valuable employee benefit
- Offer a tax deduction and savings
- Allow the employer and employee to share in the cost of retirement
- Provide a vehicle for employer profit sharing
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An ESOP is a retirement plan designed to invest primarily in employer stock. An ESOP can provide a vehicle to enhance cash flow and corporate financial strength while providing stock ownership to employees. The company can fund the plan by contributing stock, or by making cash contributions that are used to purchase stock. "Leveraged" ESOPs allow the plan to buy large blocks of stock by taking out a loan, then using cash contributions to the plan to repay the loan with deductible dollars.
Contributions made to an ESOP may be tax deductible up to 25% of the payroll of the plan participants. For a leveraged ESOP, the deductible amount can be even higher – 25% plus interest on the loan. There are also potential tax advantages for the owner who sells stock to the plan. Code Section 1042 allows the gain on sale of stock to an ESOP to be deferred through purchase of domestic securities, subject to holding requirements on the stock, and a minimum of 30% ownership of outstanding stock by the plan after the sale.
At a Glance: ESOP Plans
- Increase cash flow and working capital
- Enhance employee participation in the company’s growth
- Increase productivity and sense of ownership
- Provide a valuable tool for succession planning for key staff
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Defined benefit plans are the only qualified retirement plans to provide employees with a specified, guaranteed benefit payable at normal retirement. The benefit is usually a lifetime monthly amount based on compensation and years of service. Many plans also now allow participant to "cash out" the benefit at retirement and receive a single lump sum instead of monthly payments.
The employer makes the necessary contributions to fund the promised benefit. An annual actuarial valuation of the plan’s assets and liabilities determines the required contributions. The employer contribution is influenced by investment performance. In most cases, employers are required to pay premiums to the Pension Benefit Guaranty Corporation to insure benefits.
Defined benefit plans are ideally suited for small business employers who are unable to save for retirement in the early years of their careers. This type of qualified retirement plan allows the employer to play catch up for lost years, even if the resulting required contributions exceed 25% of compensation.
At a Glance: Defined Benefit Plans
- Provide guaranteed retirement benefits
- Allow larger deductible contributions than other plans
- Require annual contributions in the amount determined by an actuary
- Permit older business owners to fund for retirement over fewer years
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The Davis-Bacon Act requires that workers on federal and state construction contracts worth $2,000 or more be paid the "prevailing wage," which includes a specified hourly amount for fringe benefits. As an employer, you can realize significant savings in payroll taxes by putting all or a portion of the required fringe benefit amount into a qualified retirement plan. Plan contributions can be limited to the mandated Davis-Bacon fringe, reduced by the cost of health insurance and other qualified benefits, or they may include additional employer and employee contributions from a selection of options.
At a Glance: Davis-Bacon Plans
- Apply only in federal or state construction projects covered by the Davis-Bacon Act
- Produce payroll tax savings for employers
- Provide a convenient way to increase retirement contributions
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Profit Sharing Plans are designed to allow employees to share in company profits. They give the employer considerable flexibility in determining the amount of annual contributions – from 0% to 25% of covered compensation. Contributions may be allocated to the participants in proportion to their compensation, integrated with Social Security, or utilize age, service and employment position to leverage the allocation to specific groups of individuals.
At a Glance: Profit Sharing Plans
- Provide a visible, valuable employee benefit
- Offer a tax deduction for the employer contributions
- Provide a vehicle for employer profit sharing
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Money Purchase Plans can be used in lieu of, or in addition to, profit sharing plans. The annual employer contribution is fixed by a formula stated in the plan agreement; e.g., 5% of compensation for each active participant. The employer must contribute according to the plan's established formula.
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Target Benefit Plans are age-weighted money purchase plans. The contribution requirement varies with the participant’s age as well as compensation, so older participants receive larger contributions. Target benefit plans make sense if the company wants to fund the plan to meet certain targeted benefit levels and can commit to annual contributions.
At a Glance: Target Benefit Plans
- Provide larger contributions for older employees
- Offer a tax deduction and savings
- Annual employer contributions are required
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Age-Weighted/Cross-Tested Plans operate like standard profit sharing plans but the contribution allocated to each participant varies with the participant’s age as well as compensation. This allows older participants who are closer to retirement age to receive a larger share of the employer contribution. A variation of the age-weighted plan is the Cross-Tested Plan . This type of plan allows separate rates of contribution for different groups of employees, with the difference in the rates influenced by the ages and employment position/title of employees in the specified groups.
At a Glance: Age-Weighted/Cross-Tested Plans
- Provide different contribution rates to selected groups
- Offer a tax deduction and savings
- Allows employer discretion on the amount of contributions each year
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403(b) plans can be sponsored by 501(c)(3) organizations and school districts for their employees. These plans bear many similarities to 401(k) plans, but have different contribution limits, discrimination requirements, funding mechanisms, and other administrative requirements. In general, plan assets must be held in mutual funds or annuities.
At a Glance: 403(b) Plans
- Provide a visible, valuable employee benefit for 501(c)(3) organizations and school districts
- Offer a tax deduction and savings
- Allow the employer and employee to share in the cost of retirement
- Provide a vehicle for employer discretionary and matching contributions
ALERT!
The IRS will be issuing final rules for 403(b) plans. The rules are expected to be published by June 30, 2007 with a January 1, 2008 effective date.
EBR will be providing information on these changes as well as interpreting the regulations and assisting clients with implementing the new standards.
If you would like more information, please contact EBR at 406.449.5500.
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SIMPLE Plans - Many small employers who are interested in 401(k) plans may be best suited for a SIMPLE plan. These plans eliminate many of the testing requirements of a standard 401(k) plan in exchange for restrictions on contributions. The requirements for the timing of setup and communication of annual employer contribution to employees must be met.
At a Glance: 403(b) Plans
- Provide a visible, valuable employee benefit
- Offer a tax deduction and savings
- Allow the employer and employee to share in the cost of retirement
- Less expensive than 401(k) plans
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Roth Plan - Effective in 2006, 401(k) plans can allow participants to designate that some or all of their deferrals be withheld “after tax” with the new Roth provisions. As with other 401(k) plans participants can set aside dollars to grow a retirement nest egg and retain control over investment decisions if the plan allows for self-direction. Plans can allow for matching contributions on Roth contributions. Roth provisions can be adopted by employers wishing to add this feature to their current 401(k) plan by adopting an amendment and providing a copy of the summary of material modifications to participants.
At a Glance: Roth Provisions
- May be incorporated into 401(k) plans
- Offer after tax savings and tax free growth
- Allow the employer and employee to share in the cost of retirement
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Nonqualified deferred compensation plans provide payments to executives in addition to payments they may receive from retirement plans, life insurance plans, disability plans and/or severance pay plans provided to rank and file employees. These plans may be called supplemental executive retirement plans (SERPs) or, for non-profit and governmental entities, “457(b)” plans or “457(f)” plans, depending on the structure of the plan.
Nonqualified deferred compensation plans may pay a specified benefit or they may specify an annual contribution to be made. Executives may be allowed to defer a portion of their pay to a nonqualified deferred compensation plan in addition to the amounts they may contribute under a 401(k) plan.
There is more design flexibility available for nonqualified deferred compensation plans than is available for retirement plans offered to rank and file employees. For example, nonqualified deferred compensation plans do not have to be funded as benefits accrue. They can be administered on a pay-as-you-go basis. However, the rules applicable to these plans still are complex and the rules for non-profit and governmental entities are different from the rules for for-profit entities.
At a Glance: Nonqualified Deferred Compensation Plans
Offered to executives
Serve as a supplement to plans available to all employees
- Can be defined benefit or defined contribution
- Can allow for employee deferrals
- Have more design flexibility than retirement plans for rank and file employees
- Need not be funded
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