Work Place Benefit Plans

Choosing the Right Retirement Plan for Your Business


You’re an entrepreneur and you’re not looking back. You’ve opened your own business, whether alone or with other partners, and you’ve found some success. Now you’re thinking about retirement, not just for you, but also for any employees you may have.

Here are some of the retirement plan options available to business owners:

SEP IRA:

The Simplified Employee Pension (SEP) is an IRA-based plan that is funded solely by the employer. Employees are fully vested in the plan from the time they join. Business owners do, however, have the flexibility to vary contributions to a SEP from year to year or to make none at all. The SEP is often a good choice for sole proprietors or businesses in a less stable financial position. Contributions can be set at a maximum of 25% of the employee’s compensation or up to $53,000 in 2016. The limit for self-employed taxpayers is 20% of compensation.

SIMPLE IRA:

Savings Incentive Match Plan for Employees (SIMPLE) IRAs, which are restricted to businesses with 100 or fewer employees, are usually funded by both the employer and the employee. The employer must make matching contributions on behalf of eligible participants, generally the lesser of the amount deferred by the employee or 3% of the employee’s compensation. Because employers are required to contribute a set amount each year, this plan is best suited to businesses with consistent earnings. Employees may defer as much as $12,500 in 2016 to a SIMPLE plan, and those who are age 50 or older may contribute an additional $3,000.

Profit-Sharing:

Profit-sharing plans are relatively easy to administer and tend to be popular with small businesses. The plans are funded solely by the employer on a pre-tax basis, and contributions are discretionary. Many employers also require workers to remain with the company for a certain number of years before they become fully vested in the plan. With profit-sharing plans, the employer and employees can take out loans against the value of the funds in the account.

401(k):

The 401(k) is an employer-sponsored plan that allows employees to make salary deferral contributions on a pre-tax basis. Earnings in 401(k) accounts accrue on a tax-deferred basis, but they are subject to income tax upon withdrawal. While employers have the option of matching a percentage of their employees’ contributions to 401(k) accounts, they are not required to do so. The employer can set a vesting schedule for the portion of the funds contributed by the employer. The employee is responsible for managing the investments within the account. Employers may permit 401(k) plan participants to take out loans against their accounts, but this adds to the complexity of a plan. Employee contribution limits for 2016 are $18,000 for most workers or $24,000 for those aged 50 or older (with $6,000 "catch-up" contribution). The employer’s and employee’s combined contribution in 2016 may not exceed $53,000 or 100% of the employee’s pay. 

Because the 401(k) plan has many reporting requirements and is costly to administer, it is generally best suited to companies with at least 25 employees. Businesses with large disparities of pay between employees may also encounter problems with the 401(k) nondiscrimination tests, which can limit the contributions of highly compensated employees if the company’s lower paid workers do not contribute comparable percentages of their incomes.

Safe Harbor 401(k):

The Safe Harbor 401(k) offers the same benefits as the traditional 401(k), but it may allow employers to maximize contributions and still satisfy nondiscrimination rules. With a Safe Harbor 401(k), employers must make matching contributions for employees, but they have two options: Companies can make contributions for each eligible employee (even if the employee does not contribute) of 3% of annual compensation, or the company can match 100% of the first 3% of employees’ deferred contributions, plus 50% of the next 2% of employees’ contributions. While the mandatory employee match is larger with a Safe Harbor 401(k) than with most other plan types, the Safe Harbor may permit employers to make more pre-tax contributions on their own behalf.

Defined Benefit Plans:

With the rise in popularity of 401(k) plans, defined benefit plans have faded from the spotlight. However, they can still be an attractive option, particularly for business owners with few employees who are looking to accelerate their personal savings. Using a defined benefit plan, business owners may be able to set aside significantly more than they could with a defined contribution plan. In 2016, the maximum annual benefit and accrual limit is $210,000. On the other hand, defined benefit plans can be more complex and costly to administer than other options, and they are usually more expensive to fund than defined contribution plans.

Deferred Compensation Plans:

A deferred compensation plan is often established by companies that already have a qualified plan, such as the 401(k), to provide additional retirement benefits to key executives or employees. This type of plan represents an agreement whereby one person (or legal entity) promises to compensate another for services to be rendered currently, with actual payment for those services delayed until sometime in the future. Using a deferred compensation plan, an employer can offer an employee extra income that will not be taxed until some future date, usually upon retirement, death, disability, or termination of employment. Because these plans are not governed by Federal pension laws, making them “nonqualified,” they can be extremely flexible. Their very flexibility—and the associated risks—means that business owners should seek out professional guidance from tax, legal, and financial professionals before setting up these plans.

Copyright © 2016 Liberty Publishing, Inc. All Rights Reserved. BNRPVARI-AS

NONQUALIFIED DEFERRED COMPENSATION PLANS


If your business has certain executives who are critical to its success, providing them with a nonqualified deferred compensation plan (NQDC) could be a winning strategy to keep them with your company. Such a plan represents an agreement whereby one person (or legal entity) promises to compensate another for services to be rendered currently, with actual payment for those services delayed until sometime in the future. As an employer, you are offering an employee extra income that will not be taxed until some future date, usually upon retirement, death, disability, or termination of employment.

Because these plans are not governed by federal pension laws, making them “nonqualified,” they can be extremely flexible. Their very flexibility—and the associated risks—means that you should seek professional guidance from tax, legal, and financial professionals. From a business standpoint, creating the funding mechanism to help ensure the benefits are there when the employee is entitled to them is the foundation of any plan. From a tax standpoint, being sure that the employee’s benefits are taxed when received, and not before, is equally critical. It would be particularly valuable to get professional advice on the Internal Revenue Service’s “constructive receipt doctrine” (as well as other tax issues related to NQDC plans), establishing the timing for the plan’s agreement date, the length of the deferral period, and the benefit payment schedule.

Beyond the 401(k)

It’s likely that your company already offers a qualified retirement plan, such as a 401(k), which provides the employer with tax deductions for contributions up to a certain limit made to a participant’s retirement account. While these contributions certainly help employees reduce their taxable income, and defer taxes on earnings from contributions, qualified plans may limit the financial benefit sought by highly paid executives. This is because qualified plans usually restrict the compensation base used to determine the maximum annual contribution. With no limit on the compensation base, deferred compensation plans can transform a standard benefits package into a financially appealing savings vehicle for select employees.

Long-Term Incentives

Explicit in the deferred compensation plan is a contractual promise to provide future payment for ongoing services. Tethering (binding) an employee to the company through a vesting agreement is often included in a plan, although many plans offer immediate vesting, which is to the employee’s advantage. For example, an employer may stipulate that the employee must stay with the company for a certain number of years before the employee is entitled to the compensation. Such an agreement encourages loyalty and commitment on the part of the employee. Not going to work for a competitor (a noncompete agreement) can be another condition of the agreement.

What’s in Store?

The agreement you make with an employee will specify the type of benefits and how and when they will be made available. Salary continuation—such as, providing $10,000 per month for life beginning at retirement—and annual contributions to an investment account whose balance is then paid at retirement are typical benefit formulas of NQDCs. Whether the money is actually put into an account, or merely exists on your books, is up to you. Employers who offer these plans, however, must be confident that the future profitability of their businesses will cover promised payments. Employees will want assurance that their compensation will be there for them. One method of providing assurance is to set up a Rabbi Trust, which is a type of escrow account that provides some protection for the deferred compensation funds in the event of a hostile takeover or other type of management change. (Protection does not apply to the claims of the employer’s general creditors.) The protected funds may be invested or used to purchase life insurance or annuity products.

As Americans take on more responsibility for funding their own retirement, NQDCs may become a standard component of benefit packages. Forward-looking financial institutions have packaged these plans to make it easy for your company to attract and retain talented executives. When creating your company’s benefits package, NQDCs can play a valuable role.

Copyright © 2016 Liberty Publishing, Inc. All Rights Reserved. BNDDEF01-AS