Pensions: Qualified Retirement Plans

Defined Contribution Plan:

A retirement plan under which the annual contributions made by the employer or employee are generally stated as a fixed percentage of the employee’s compensation. The amount of retirement benefits is not guaranteed; rather, it depends upon the investment performance of the employee’s account. The maximum percentage is 25% of eligible payroll.

The IRS has imposed a maximum allowable salary that may be considered. For 2018, that amount is $275,000. The IRS also imposes an annual contribution limit. For 2018 that amount is $55,000. If the plan has a 401(k) component, participants age 50 or older may contribute an additional $6,000 “catch-up” contribution. A participant may defer up to 100% of their income up to a maximum of $18,500.

The following are various types of Defined Contribution Plans:

Profit Sharing Plan: Provides for tax-deductible, discretionary employer contributions to be made on behalf of eligible participants. Plan design is based on age, compensation and ownership, which determines the amount each participant will receive. This plan can be combined with a 401(k) plan, although the maximum contribution per person for 2018 is $55,000 ($61,000 if age 50 or over), which includes employee 401(k) deferrals.

401(k) Plan: Allows employees to defer a portion of their income up to a maximum of $18,500 or $24,500 if age 50 or older (2018 limits). There are discrimination tests that must be performed to ensure there is not too great a discrepancy between the rank and file and the highly-compensated employees. However, if a safe harbor plan is adopted, which requires an employer contribution, this test can be avoided.

Roth 401(k) Plan: Allows for employees to contribute after-tax income with the same maximums as the traditional 401(k). There are no salary requirements and growth on the assets is tax-deferred. Also, as long as the money is held for at least 5 years in the Roth 401(k), distributions will be tax-free. The 401(k) plan must allow for this option in the plan document to make it available to participants.

Safe Harbor Contribution: These are employer contributions for companies with 401(k) plans that may not pass the discrimination tests because of the variance between contributions from the rank and file and the highly-compensated employees. There are two options available: One is a 3% employer contribution for all employees, whether they are deferring into the 401(k) plan or not, and the other is an employer matching contribution. The employer must match 100% of the first 3% of a 401(k) participant’s contribution and 50% of the next 2% of a 401(k) participant’s contribution. In other words, if a participant defers at least 5% of their income, the employer’s matching contribution will be 4% of their income, all based on the maximum eligible compensation of $275,000 in 2018. All safe harbor contributions are 100% vested.

Defined Benefit and Cash Balance Plans:

These types of plan designs are most beneficial for companies, partnerships or sole proprietors who would like to contribute more than is allowed under a Profit Sharing and 401(k) plan. It is most beneficial for participants ages 40 and older. The contribution is calculated from a formula provided by an actuary and is based on funding for a future retirement benefit. The shorter the period of time to retirement, the greater the potential tax-deductible contribution to the Plan. The actuary uses age, compensation, projected interest rate returns and years of service to determine the desired contribution.

There are no maximums for the contribution amounts but there are for the future benefit amounts. At retirement participants choose between an annual retirement benefit or a lump-sum equivalent that can be rolled over into an IRA to further defer taxes. Most participants choose the lump-sum equivalent to maintain control over their assets and to invest for future additional growth on the investment.

Cash Balance plans are another form of Defined Benefit and may be combined with Profit Sharing and 401(k) plans.

What is outlined above is just a brief summary of the different plan designs available. Please contact us, and we will design a customized proposal for you based on your unique objectives.