Types of Plans
Defined Contribution Plans
Defined Contribution plans are plans that are defined by the contribution made to the plan each year, either by the employer or the employer and the employee.
This is a type of defined contribution plan sponsored by the employer. It gives eligible employees the right to elect to make contributions. 401(k) contributions are generally contributed through payroll deduction and in some plans the employer will elect to make matching contributions as well. In most 401(k) plans, a diverse choice of investments are provided so the employee can choose how to invest their contributions (and any employer contributions as well).
Automatic Enrollment 401(k) Plans
Employees automatically participate in this plan and contribute a designated percentage of their pay. These plans generally encourage higher rates of participation. Because these automatic enrollment plans require an election NOT to participate, far more employees will end up covered. The result is that the nondiscrimination testing is easier to pass. However, it can also raise employer costs for matching contributions, as well as administrative costs, since so many more employees will end up participating in the plan.
Safe Harbor 401(k) Plans
These types of 401(k) plans are exempt from the nondiscrimination testing in exchange for the employer providing a certain level of fully vested contributions to rank-and-file employees, either as a minimum percentage of pay for all eligible employees or as a required rate of matching contributions.
Profit Sharing Plans
The employer has the discretion to make contributions on a year by year basis. There is generally no minimum amount required. Each contribution is flexible based on the profit of the business that year. They are often used in conjunction with 401k plans. In profit sharing plans, the most any employee can receive in one year is subject to IRS limits.
New Comparability Profit Sharing Plans
In this type of profit sharing plan, the eligible employees are placed into different contributions tiers so that the allocations are no longer a uniform percentage of employee compensation. This enables the employer to design the plan to favor certain select groups of employees by providing greater contributions. IRS Regulations require that these sorts of allocations be tested each year to meet nondiscrimination requirements. In many situations, a New Comparability plan can be designed to favor a select group of key employees while still allocating contributions deemed sufficient to meet IRS coverage and nondiscrimination tests.
Defined Benefit Plans
Defined Benefit Plans are plans that are defined by the benefit to be paid out at the retirement of each participant. The employer is the sole funder for the plan, and makes a contribution each year in order to meet the ultimate benefit goal.
Traditional Defined Benefit Plans
This type of pension plan is defines the benefit to be distributed to the participant at a decided retirement age. Each year, an enrolled actuary certifies to the amount that the employer is required to contribute in order to meet IRS minimum funding standards. IRS funding rules often permit a range of allowable contributions so that the employer can fund higher amounts in good times and, in certain circumstances, reduce the funding during leaner times.
One of the main differences between a Defined Benefit and a Defined Contribution Plan is that the employer bears the investment risk and reward (in the form of higher or lower contributions) in a pension plan. These plans work particularly well when the employer is looking for tax deductible contributions that exceed the normal limits of a Defined Contribution Plan. Instead of an employee being limited to a maximum annual allocation of $53,000 (the current 2015 limit), a Defined Benefit plan is only limited in the amount of retirement benefit that it can fund. The result is that in many situations, the tax deductible contributions funding an individual’s retirement benefit could be $150,000 or higher.
Cash Balance Plans
This type of pension plan is often referred to as a “hybrid” plan. It is defined benefit plan that acts like a defined contribution plan. The employees do not make contributions, but the employer makes an annual contribution on behalf of all the employees. The contribution is defined as a pay credit and an interest credit. The employee receives an annual report indicating how much their account has grown with their interest credit and their pay credit. The benefit of a cash balance plan is that the employer is able to save much more for retirement than with a 401(k) alone. And because it is a pension plan, the contributions for an employee can be much higher than they would be in a Profit Sharing Plan.
Overfunded Defined Benefit Plans
Sometimes, a defined benefit plan will accumulate funds in excess of that which are necessary to pay benefits. The government’s “solution” to this problem is to terminate the plan, and pay ruinous taxes on the excess – perhaps as much as 85%! However, there are alternative solutions. We can tailor a solution to your individual needs, and enable you to avoid paying an exorbitant tax bill.
Note that all of the plans described above are subject to complex IRS and DOL requirements regarding coverage, nondiscrimination, annual reporting and disclosure to the government, employee notifications, Plan Document maintenance and other rules and regulations. In order to gain the considerable benefits and tax advantages provided by these plans, it is essential that you seek out a consulting firm with the expertise and experience to make sure you avoid the many possible regulatory pitfalls. Economic Group Pension Services Inc., with its staff of experienced consultants, actuaries and attorneys, understand the rules to help you keep your plan operating in a way that continues to meet your objectives, while limiting risk.
Whether you offer a defined benefit pension, a defined contribution plan, or both, we work with you to determine the right approach to design, funding, investing, governing, and employee engagement. We take into account the nature of your business, the composition of your workforce and your goals for benefit adequacy, competitiveness and cost management.
“We help our clients navigate the maze of available options, without crushing them under details.”