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Introduction

If you are involved with a corporation, one of your primary goals is to maximize the profitability of the business. Your workforce is, of course, one of the keys to achieving this goal. Most successful businesses strive to attract and retain the highest-quality employees, and to promote productivity. One of the benefits that many employees value most is a good retirement plan.

Retirement plans encourage systematic savings for the future and, in the case of qualified plans (and some nonqualified plans), can offer significant tax benefits for you, your business, and your employees. Finding the right retirement plan for your business can sometimes be a challenge, however. You can begin the selection process by identifying the types of plans that are most appropriate for a corporation.

Qualified Vs. Nonqualified Plans

Qualified retirement plans offer significant tax advantages to both employers and employees. Employers are generally permitted to deduct their contributions on their federal income tax returns, while participants can benefit from pretax or after-tax contributions and tax-deferred (and in some cases, tax-free) growth. In return for these tax benefits, a qualified plan must adhere to strict IRC (Internal Revenue Code) and ERISA (Employee Retirement Income Security Act) guidelines regarding participation in the plan, vesting, funding, nondiscrimination, disclosure, and fiduciary matters.

In contrast to qualified plans, nonqualified retirement plans are often not subject to the same set of ERISA and IRC guidelines. As you might expect, this freedom from extensive requirements often provides nonqualified plans with greater flexibility for both employers and employees. In addition, nonqualified plans are often less expensive to establish and maintain than qualified plans.

Generally, the main disadvantages of nonqualified plans are (a) they are typically not as beneficial as qualified plans from a tax standpoint, (b) they are generally available only to a select group of employees, and (c) plan assets are not protected in the event of the employer's bankruptcy. For these reasons, qualified plans usually appeal to the largest number of employers and employees.

Defined Benefit Plans Vs. Defined Contribution Plans

Qualified retirement plans can be divided into two main categories: defined benefit plans and defined contribution plans. In today's environment, most new employer-sponsored retirement plans are defined contribution plans.

Defined Benefit Plans

The traditional defined benefit plan (a "traditional pension") is a qualified employer-sponsored retirement plan that guarantees the employee a specified level of benefits at retirement (for example, an annual benefit equal to 30 percent of an employee's average final pay). As the name suggests, it is the retirement benefit that is defined, not the level of contributions to the plan. The services of an actuary are generally needed to determine the annual contributions that an employer must make to the plan to fund the promised retirement benefits.

Contributions may vary from year to year, depending on the performance of plan investments and other factors. Defined benefit plans are generally funded solely by the employer. The traditional defined benefit pension plan is not as common as it once was, as many employers have sought to shift responsibility for retirement to employees. However, a hybrid type of plan called a "cash balance plan" has gained popularity in recent years.

Defined Contribution Plans

Unlike a defined benefit plan, a defined contribution plan provides each participating employee with an individual plan account. Here, it is the plan contributions that are defined, not the ultimate retirement benefit. Contributions are sometimes defined in the plan document, often in terms of a percentage of the employee's pretax compensation. Alternatively, contributions may be discretionary, determined each year, with only the allocation formula specified in the plan document. With some types of plans, employees may be able to contribute to the plan.

A defined contribution plan does not guarantee a certain level of benefits to an employee at retirement or separation from service. Instead, the amount of benefits paid to each participant at retirement or separation is the vested balance of his or her individual account. An employee's vested balance consists of: (1) his or her own contributions and related earnings, and (2) employer contributions and related earnings to which he or she has earned the right through length of service. The dollar value of the account will depend on the total amount of money contributed and the performance of the plan investments.

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Specific Types of Retirement Plans

The following types of retirement plans are generally considered most appropriate for a corporation:

  • 401(k) plan: A 401(k) plan, sometimes called a cash or deferred arrangement (CODA), is a qualified defined contribution plan in which employees may elect to defer receipt of income. The amount deferred consists of pretax dollars that are invested in the employee's plan account. The employer may match all or part of the employees' deferrals to encourage employee participation. The 401(k) plan is the most widely used type of retirement plan. 401(k) plans can also offer employees the opportunity to make after-tax Roth contributions.
  • Profit-sharing plan: A profit-sharing plan is a qualified defined contribution plan that generally allows for some discretion in determining the level of annual employer contributions to the plan. In fact, the business can often contribute nothing at all in a given year if it so chooses. The amount of contributions may be based on a written formula in the plan document, or may be essentially at the employer's discretion. With a typical profit-sharing plan, employer contributions range anywhere from 0 to 25 percent of an employee's compensation.
  • Age-weighted profit-sharing plan: An age-weighted profit-sharing plan is a type of profit-sharing plan in which contributions are allocated based on the age of plan participants as well as on their compensation. This type of plan benefits older participants (generally, those having fewer years until retirement) by allowing them to receive much larger contributions to their accounts than younger participants.
  • New comparability plan: A new comparability plan is a variation of the traditional profit-sharing plan. This type of plan is unique in that plan participants are divided into two or more classes, generally based on age and other factors. A new comparability plan can often allow businesses to maximize plan contributions to higher-paid workers and key employees and minimize contributions to the other employees.
  • Money purchase pension plan: A money purchase pension plan is a qualified defined contribution plan in which the employer makes an annual contribution to each employee's account in the plan. The amount of the contribution is determined by a set formula that cannot be changed, regardless of whether the corporation is showing a profit. Typically, the business's contribution will be based on a certain percentage of an employee's compensation.
  • Target benefit plan: A target benefit plan is a hybrid of a defined benefit plan and a money purchase pension plan. It resembles a defined benefit plan in that the annual contribution is based on the amount needed to fund a specific amount of retirement benefits (the "target" benefit). It resembles a money purchase pension plan in that the annual contribution is fixed and mandatory, and the actual benefit received by the participant at retirement is based on his or her individual balance.
  • Defined benefit plan: A defined benefit plan is a qualified retirement plan that guarantees the employee a specified level of benefits at retirement (for example, an annual benefit equal to 30 percent of final average pay). As the name suggests, it is the retirement benefit that is defined, not the level of contributions to the plan. The services of an actuary are generally needed to determine the annual contributions that an employer must make to the plan to fund the promised benefits. Contributions may vary from year to year, depending on the performance of plan investments and other factors. Defined benefit plans allow a higher level of employer contributions than most other types of plans, and are generally most appropriate for large companies with a history of stable earnings. Defined benefit plans are generally funded solely by the employer.
  • Cash balance plan: A cash balance plan is a type of qualified retirement plan that has become increasingly common in recent years as an alternative to the traditional defined benefit plan. Though it is technically a form of defined benefit plan, the cash balance plan is often referred to as a "hybrid" of a traditional defined benefit plan and a defined contribution plan. This is because cash balance plans combine certain features of both types of plans. Like traditional defined benefit plans, cash balance plans pay a specified amount of retirement benefits. However, like defined contribution plans, participants have individual plan accounts for record-keeping purposes.
  • Payroll deduction IRA plan: A payroll deduction IRA plan is a type of arrangement that you can establish to allow your employees to make payroll deduction contributions to IRAs (traditional or Roth). It can be offered to your employees instead of a more conventional retirement plan (such as a 401(k) plan), or to supplement such a plan. Each of your participating employees establishes and maintains a separate IRA, and elects to have a certain amount deducted from his or her pay on an after-tax basis. That amount is then invested in the participant's designated IRA. Payroll deduction IRAs are generally subject to the same rules that normally apply to IRAs.
  • SEP plan: A simplified employee pension (SEP) plan is a tax-deferred retirement savings plan that allows contributions to be made to special IRAs, called SEP-IRAs, according to a specific formula. Generally, any employer with one or more employees can establish a SEP plan. With this type of plan, you can make tax-deductible employer contributions to SEP-IRAs for yourself and your employees (if any). Except for the ability to accept SEP contributions from employers (allowing more money to be contributed) and certain related rules, SEP-IRAs are virtually identical to traditional IRAs.
  • SIMPLE IRA plan: A SIMPLE IRA plan is a retirement plan for small businesses (generally those with 100 or fewer employees) and self-employed individuals that is established in the form of employee-owned IRAs. The SIMPLE IRA plan is funded with voluntary pre-tax employee contributions and mandatory employer contributions. The annual allowable contribution amount is significantly higher than the annual contribution limit for traditional and Roth IRAs, but less than the limit for 401(k) plans.
  • SIMPLE 401(k) plan: A SIMPLE 401(k) plan is a qualified retirement plan for small businesses (generally those with 100 or fewer employees) and self-employed persons, including sole proprietorships and partnerships. Structured as a 401(k) cash or deferred arrangement, this plan was devised in an effort to offer self-employed persons and small businesses a tax-deferred retirement plan similar to the traditional 401(k), but with less complexity and expense.
  • Thrift/savings plan: A savings or thrift plan is a qualified defined contribution plan that is similar to a profit-sharing plan, but has features that provide for (and encourage) after-tax employee contributions to the plan. The employee must pay tax on his or her own contributions before they are invested in the plan. Typically, a thrift/savings plan supplements after-tax employee contributions with matching employer contributions. Many thrift plans have been converted into 401(k) plans.
  • Employee stock ownership plan (ESOP): An ESOP, a type of stock bonus plan, is a qualified defined contribution plan in which participants' accounts are invested in stock of the employer corporation. This type of plan is funded solely by the employer. When a plan participant retires or leaves the company, the participant receives his or her vested balance in the form of cash or employer securities.

Tip: Employers who maintain qualified retirement plans can also allow employees to make their regular IRA contribution--traditional or Roth--to a special account set up under the retirement plan. These accounts, called "deemed IRAs," function just like regular IRAs.

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

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The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.



TRG Retirement Guide

Tags: Financial Planning, Lump Sum, Pension, Retirement Planning