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Retirement and Benefit Plans
What is a Retirement Plan?
“Qualified” Retirement Plan Defined
Advantages and Benefits
How a Plan Works
Types of Qualified/Non-Qualified Plans
Profit Sharing
401(k)
Defined Benefit Pension Plan
Money Purchase Pension Plan
Target Benefit Pension Plan
ESOP
SIMPLE
SEP
Non-Qualified Plans
Welfare Benefit Plan
125 Cafeteria PlanWhat is a Retirement Plan?
You may know a retirement plan by calling it a “401(k)”, a “profit sharing plan”, a “pension”, a “TSA” or a “403(b)”. These are all types of retirement plans with many different characteristics. All retirement plans are actually divided into two categories: Defined Benefit and Defined Contribution.
A defined benefit pension plan promises to pay a fixed monthly benefit upon retirement. A formula or benefit level is defined. Employer contributions are determined actuarially on the basis of benefits payable, mortality, work force turnover and other factors. Certain benefits may be insured by the Pension Benefit Guaranty Corporation (“PBGC”), a government agency. These plans do not offer “individual accounts”.
A defined contribution plan, also known as an “individual account plan”, provides for a separate account for each participant. Contributions are made by the employer under a specified formula. Employees may also be permitted to voluntarily contribute a portion of their salary under a cash or deferred arrangement. Contributions accumulate along with investment earnings, in the employee’s account. There are several different types of defined contribution plans – profit sharing, 401(k), 403(b), money purchase, stock bonus and ESOP, target benefit, SIMPLE and SEPs.
401(k), Simple, ESOP or Profit Sharing Plans are excellent tax shelters regulated by the Internal Revenue Service. It is now highly recommended that Employers and Employees utilize these plans to take charge, to save and to prepare for retirement with “Tax Deferred Savings”.
“Qualified” Retirement Plan Defined
The term “qualified” means the plan is afforded special tax treatment by meeting requirements defined by the Internal Revenue Code. The Employee Retirement Income Security Act (“ERISA”) is a technical piece of legislation enacted in the early 1970’s. It deals with the establishment, operation and administration of employee benefit plans. ERISA defines an “employee pension benefit plan” or “pension” as any plan, fund or program which provides retirement income to employees or results in a deferral of income by employees for periods extending to the termination of employment.
Advantages and Benefits
A “qualified” retirement plan is one of the best ways to take charge and prepare to save. There is no better way for a company to accumulate a retirement benefit for its loyal employees—and itself—than to establish a tax deferred plan.
There are numerous benefits for employers to establish retirement plans for their company:
ü Tax Advantages
A company is allowed a current tax deduction for its contributions to the plan. An employee pays not taxes on money contributed until a distribution is made. Earnings from the investments made with funds in the plan accumulate tax-free. Distributions from the plan may be afforded favorable income tax treatment.
ü New Employee Recruitment
A qualified retirement plan assists an employer in attracting and recruiting employees.
ü Continuing Employee Incentive
It provides an incentive for current employees to be more productive for the good of the company.
ü Reduce Employee Turnover
It helps to decrease employee turnover by giving employees the opportunity to accumulate funds over time for their retirement and for the security of their loved ones in the future.
ü Working Owners and Self-Employed Individuals
A qualified retirement plan is very attractive to working owners of closely held corporation and to self-employed individuals. It gives their companies the best opportunity to accumulate large sums through tax free build up of contributions.
ü Retirement Plans Protected
Plans are always protected from creditors such as bankruptcy courts, liens, etc.
How a Plan Works
The administration and enforcement of ERISA is complex. The Department of Labor (“DOL”), the Treasury (Internal Revenue Service) and the Pension Benefit Guaranty Corporation (“PBGC”) divide jurisdiction over the plans. Hence, each entity has its own rules and regulations.
There are four basic rules all retirement plans must meet to “qualify” for favorable tax treatment:
ü The plan must be a definite written program.
ü The plan must be communicated to the employees.
ü The plan must be permanent.
ü The plan must prohibit the use or diversification of funds for purposes other than the exclusive benefit of the employees or their beneficiaries.
There are also rules related to minimum coverage, minimum participation, discrimination, vesting, minimum distributions, minimum benefits, joint and survivor annuity rights, commencement of benefit payments, limitations on benefit accrual and contributions, compensation limits, defined benefit assumptions, plan loans, domestic relations orders, reporting, as well as many other compliance related issues.
Therefore, it is important to comply and understand your role in a retirement plan; and there are many roles to fill. Plan sponsor, plan administrator, trustee, administrative committee member, participant, party-in-interest, fiduciary, highly compensated employee, member of controlled group or affiliated service organization, enrolled actuary, officer, owner, key employee, beneficiary, etc. Each role is important and has to comply with the rules that govern them.
In summary, it is very important to keep your team of advisors involved in your retirement plan.
In the establishment and administration of your retirement plan, the assistance of an independent Third Party Administrator (TPA) can greatly contribute to the success of your plan. ABA, Inc. is a professional independent TPA that is ready and willing to take a hands-on approach in maintaining the “qualified” status of your plan. We will assist you in performing all testing, required reporting to interested parties and adherence to federal regulations.
Changes to the laws governing qualified plans occur regularly. We will keep you abreast of these changes and assist you in the continued qualification of your plan.
Remember, you must take financial responsibility for your security at retirement. Help yourself get the retirement you’ve dreamed of by utilizing the best method available today. It’s never too late to start participating in a plan!
Types of Qualified/Non-Qualified Plans
Qualified Plans provide you the opportunity to offer a retirement program for you and your employees. They enhance your competitive position in the marketplace, provide tax deductions through contributions and administrative expenses, motivate employees to take more interest in the company’s success and provide for an improved lifestyle at retirement.
Profit Sharing Plans:
Profit Sharing Plans are the most flexible plan with respect to the amount of the contribution made each year. Contributions are generally discretionary but the company must agree to make “substantial and “recurring” deposits. In years when the company does not make profits, it could elect to forgo or limit the amount of contribution to be made for a particular year.
These plans involve the sharing of company profits with the employees each year. The plan must define the formula for allocating these contributions to employees. There are various methods in which profit sharing contributions can be allocated to eligible participants:
ü Compensation to total compensation (“pro-rata”)
ü Permitted Disparity (Integration)
ü Age-weighted
ü Tiered approach with “cross-testing”
ü Units such as years of services
The maximum contribution that may be made by the company each year is 25% of eligible compensation. In some cases individual participants may receive an amount greater than 25% due to the allocation formula, but in no event, can the funding/deductibility of the employer contribution exceed 25% on a company level.
In certain situations safe harbor plans provide an excellent opportunity for retirement savings for the highly compensated employee while assuring the non-highly are benefiting.
Currently, 401(k) plans are the most popular type of plan with employees and employers. These plans allow for pre-tax employee contributions, with or without matching employer contributions.
Employees’ contributions (“deferrals”) are limited by law to an annual amount limit. In 2005, the maximum is $14,000.00. This amount may be increased by the government each year. The sum of all employee and employer contributions for a given participant in any year cannot exceed the lesser of $42,000.00 or 100% of the participant’s compensation.
401(k) Plans can also provide for various safe harbor provisions.
Defined Benefit Pension Plan:
This plan type pre-defines the monthly benefit amount an employee will receive beginning at Normal Retirement Age. The employer is required in most cases to provide the minimum funding requirements, regardless of profitability. The annual contribution is calculated utilizing actuarial methods. These plans require additional government reporting.
A newer trend in plan design is to combine some aspects of Defined Benefit plans with some aspects of a Defined Contribution plan. In choosing this type of plan design, employers are able to maximize the amount they are can contribute to their own accounts while reducing employee costs and also giving their employees the opportunity to defer and receive contributions to their own accounts.
Money Purchase Pension Plan:
Company contributions are mandatory and usually based solely on each participant’s compensation. The obligation to fund this plan is what makes it different from a profit sharing plan. If the company fails to make a contribution, a penalty tax to the company is imposed.
Retirement benefits are based upon how much is in the participant’s account at the time of retirement—whatever pension the money can purchase. The maximum formula allowed under this plan is also 25% of compensation.
Target Benefit Pension Plan
A target benefit is a cross between a defined benefit plan and a money purchase pension plan. It is like a defined benefit plan in that contribution allocations are based upon an amount needed to accumulate a fund sufficient to pay a projected retirement benefit (the target benefit) to each participant at retirement age. It is like a money purchase plan because in no event will a participant receive more than a money purchase plan will allow. This is why it is a “target” and not a “defined” benefit.
Employee Stock Ownership Plan (“ESOP”):
ESOPs allow employees to become stockholders in the company through employer contributions of the company stocks. These plans are also governed by many complex rules.
Stock bonus and employee stock ownership plans provide benefits similar to those of profit sharing plans, except that the contributions by the employer are not necessarily dependent on profits. Contributions to these plans must primarily be made in shares of company stock.
A stock plan can be used as a market for company stock, as a method of increasing the cash flow of the company, a means of financing the company’s growth or an estate planning vehicle for the owner of a closely held corporation.
Target Benefit Pension Plan:
A target benefit is a hybrid or cross between a defined benefit plan and a money purchase pension plan.
In a Money Purchase Pension Plan, company contributions are mandatory and usually based solely on each participant’s compensation. In a Target Benefit Pension Plan, contribution allocations are based upon an amount needed to accumulate a fund sufficient to pay a projected retirement benefit (the target benefit) to each participant at retirement age. However, in no event can a participant receive more than a money purchase plan allows. This is why it is a “target and not a “defined” benefit.
SIMPLE stands for Savings Incentive Match Plan for Employees. These types of plans are advantageous for employers because they eliminate most of the reporting requirements imposed on other qualified plans.
To qualify, an employer must have 100 employees or less who earned at least $5,000 in compensation during the previous year. Also, the employees cannot maintain any other type of employer sponsored retirement plan. For 2005, and employee can defer up to $10,000. Each year the employer is required to make a matching contribution.
Simplified Employee Pensions (“SEPs”):
SEPs are intended to encourage small employers to setup retirement plans for their employees by removing much of the expenses and paperwork associated with pension plans. An employer may contribute up to the lesser of $42,000.00 in 2005, or 25% of compensation to individual retirement accounts (IRAs) for each employee. In combination with a Salary Reduction Agreement, the employees many elect to defer up to $10,000.00 of their salary to the SEP if at least 50 percent of employees participate.
SEPs have slightly different rules related to eligibility, vesting, testing, contributions limits and withdrawals.
Non-Qualified Plans:
A non-qualified plan is designed to enhance the current benefit program for a select group or individual employee. These plans are tailored to the needs of the interested parties. The employee’s are generally provided a deferred benefit taxable at the time it is received. The company does not receive a deduction until the time it is received by the employee.
Welfare Benefit Plans:
A welfare benefit plan is not a retirement plan, but is a benefit plan that provides benefits such as medical, dental, life insurance, apprenticeship and training, scholarship funds, severance pay, disability, etc.
Benefits are provided through insurance contracts or policies issued by an insurance company.
125 Cafeteria Plans:
A cafeteria plan is not a retirement plan, but is a benefit plan that saves the employer and employees a significant amount of money in healthcare costs and other life expenses.
Internal Revenue Code Section 125 allows for employees to defer pre-tax dollars (compensation) towards the payment of certain expenses. Employees are offered a “menu” of options to choose from. The most popular options include dependent care expenses (daycare), medical and dental premiums, group life insurance premiums, and other medical expenses. The amounts deferred are exempt from taxes such as FICA, Federal and certain State taxes.
Establishing a 125 Cafeteria Plan is beneficial to both you and your employees.
First, you will benefit by a reduction in Federal, FICA, Social Security, Medicare (and in some cases state) taxes. Second, the money that is deposited into your Employees’ Cafeteria Plan Account comes straight out of their gross pay, therefore avoiding taxes. Your Employees will be paying less for their health expenses and you, the employer, will be paying less in taxes.
Please visit our 125 Café website to find out how ABA, Inc. can help you and your employees save money with a cafeteria plan:
401(k)
Profit Sharing
Money Purchase
SIMPLE
Defined Benefit Cafeteria Plan
Welfare Benefit
Target
Benefit
ESOP
125 Cafeteria Plan
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