Employer Retirement Plans

A qualified plan must meet a certain set of requirements set forth in the Internal Revenue Code such as minimum coverage, participation, vesting and funding requirements. In return, the IRS provides tax advantages to encourage businesses to establish retirement plans including:

• Employer contributions to the plan are tax deductible.
  
• Earnings on investments accumulate tax-deferred, allowing contributions and earnings (subject to market fluctuation) to compound at a faster rate.
  
• Employees are not taxed on the contributions and earnings until the funds are distributed.
  
• Employees may make pretax contributions to certain types of plans.
  
• Ongoing plan expenses are tax deductible.
  

In addition, sponsoring a qualified retirement plan offers the following advantages:

• Attract experienced employees in a very competitive job market: Retirement plans have become a key part of the total compensation package.
  
• Retain and motivate good employees: A retirement plan can help you maintain key employees and reduce turnover.
  
• Help employees save for their future since Social Security retirement benefits alone will be an inadequate source to support a reasonable lifestyle for most retirees.
  
• Qualified plan assets are preserveed from creditors of the employer and employee.
  

Employers can choose between two basic types of retirement plans: defined contribution and defined benefit. Both a defined benefit and a defined contribution plan may be sponsored to maximize benefits. Our consultants can help you choose the right plan for your company. Listed below is a description of the types of plans that are available.

Under a defined contribution plan, the contribution that the company will make to the plan and how the contribution will be allocated among the eligible employees is defined. Individual account balances are maintained for each employee. The employee's account grows through employer contributions, investment earnings and, in some cases, forfeitures (i.e., 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.

Since the contributions, investment results and forfeiture allocations vary year by year, the future retirement benefit 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.

Employer account balances may be subject to a vesting schedule. Non-vested account balances forfeited by former employees can be used to reduce employer contributions, plan expenses, or can be reallocated to active participants.

The maximum annual amount that may be credited to an employee's account (taking into consideration all defined contribution plans sponsored by the employer) is limited to the lesser of 100% of compensation or $53,000 in 2015.

Tax deduction limits must also be taken into consideration. Employer contributions cannot exceed 25% of the total compensation of all eligible employees.

The profit sharing plan is generally the most flexible qualified plan that is available. Company contributions to a profit sharing plan are usually made on a discretionary basis. Each year the employer decides the amount, if any, to be contributed to the plan. For tax deduction purposes, the company contribution cannot exceed 25% of the total compensation of all eligible employees. The maximum eligible compensation that can be considered for any single employee is $265,000 in 2015.There are several different profit sharing allocation formulas a company can consider:

Pro-rata
Contribution is allocated as a percentage of each employee's compensation.

Integration with Social Security
The profit sharing contribution is allocated using a formula that is integrated with Social Security, resulting in larger contributions for employees earning more than the Social Security Taxable Wage Base.

Age-Weighted
Profit sharing plans may also use an age-weighted allocation formula that takes into account each employee's age and compensation. 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 skew benefits in favor of older employees.

New Comparability
New comparability plans, sometimes referred to as "cross-tested plans," are usually profit sharing plans that are tested for nondiscrimination as though they were defined benefit plans. By doing so, certain employees may receive much higher allocations than would be permitted by standard nondiscrimination testing. New comparability plans are generally utilized by small businesses that want to maximize contributions for key, while minimizing contributions for all other eligible employees.

Employees are separated into groups such as owners and non-owners. Each group may receive a different contribution percentage. For example, a higher contribution percentage may be given for the owner group than for the non-owner group, as long as the plan satisfies the nondiscrimination requirements.

Virtually all 401(k) plans are profit-sharing plans. More and more employees perceive 401(k) plans as a valuable benefit which have made them the most popular type of retirement plan today. Employees can benefit from a 401(k) plan even if the employer makes no contribution. Employees can voluntarily elect to make pre-tax contributions through payroll deductions up to an annual maximum limit ($18,000 in 2015).

The plan may also permit employees age 50 and older to make additional "catch-up" contributions, up to an annual maximum limit ($6,000 in 2015).

The 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 of the earnings on the employee's Roth contributions if the distribution meets certain requirements).

The employer will often match some portion of the amount deferred by the employee in order to encourage greater employee participation (e.g., 25% match on the first 4% deferred by the employee). 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 which limit how much the group of employees referred to as "Highly Compensated Employees" can defer based on the amounts deferred by the "Non-Highly Compensated Employees." In general, employees who fall into the following two categories are considered to be Highly Compensated Employees:

• An employee who owns more than 5% of the employer at any time during the current plan year or immediately preceding plan year (ownership attribution rules apply which treat an individual as owning stock owned by his or her spouse, children, grandchildren or parents); or
  
• An employee who received compensation in excess of the indexed limit in the preceding plan year (indexed limit is $120,000 in 2015). The employer may elect that this group be limited to the top 20% of employees based on compensation.
  

401(k) Safe Harbor Plans

The plan may be designed to satisfy "401(k) Safe Harbor" requirements which can eliminate nondiscrimination testing. The Safe Harbor requirements include certain minimum employer contributions and 100% vesting of employer contributions that are used to satisfy the Safe Harbor requirements. The benefit of eliminating the testing is that Highly Compensated Employees can defer up to the annual limit ($18,000 in 2015) without concern for how much the Non-Highly Compensated Employees defer. The employer safe harbor contribution can be in the form of a matching contribution that would only go to employees that contribute. Alternatively, the safe harbor contributions can be made in the form of an employer non-elective contribution that would go to all eligible employees whether they contribute or not.

*Note: All 401(k) plans are profit-sharing plans by law with an employee contribution feature.

A defined benefit pension plan is a type of pension plan in which an employer provides a specified monthly benefit on retirement that is predetermined based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns. A defined benefit plan is 'defined' in the sense that the benefit formula is defined and known in advance. In the United States, 26 U.S.C. § 414(j) specifies a defined benefit plan to be any pension plan that is not a defined contribution plan where a defined contribution plan is any plan with individual accounts. A traditional pension plan that defines a benefit for an employee upon that employee's retirement is a defined benefit plan.

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In a typical cash balance plan, a participant's account is credited each year with a "pay credit" 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 are borne solely by the employer.

When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance. For example, assume that a participant has an account balance of $100,000 when he or she reaches age 65. If the participant decides to retire at that time, he or she would have the right to an annuity based on that account balance. Such an annuity will provide a guaranteed lifetime income. (what is the basis for this assumption?). In many cash balance plans, however, the participant could instead choose (with consent from his or her spouse) to take a lump sum benefit equal to the $100,000 account balance.

If a participant receives a lump sum distribution, that distribution generally can be rolled over into an IRA or to another employer's plan if that plan accepts rollovers.

The benefits in most cash balance plans, as in most traditional defined benefit plans, are preserveed, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation.

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