As an employer, are there tax advantages to establishing a retirement plan?
Yes, employer contributions are deductible from the employer’s income; employee contributions are not taxed until distributed to the employee, and money in the plan grows tax-free.
There is a tax credit that small employers can claim for part of the ordinary and necessary costs of starting certain types of plans. The credit equals 50 percent of the cost to set up and administer the plan, up to a maximum of $500 per year for each of the first 3 years of the plan;
How does an Employer establish a qualified plan?
Select a Third Party Administrator to manage administrative duties
Adopt a plan document (written rules for operating the plan)
Select an investment advisor to recommend funds, monitor fund performance and advise participants
Select an investment company to hold the plan’s assets
Notify employees and enroll them in the plan
What are the most common types of plans an employer can establish?
Profit Sharing Plan
This plan type consists of employer contributions only. Contributions to a profit-sharing plan are discretionary, meaning there is no set amount the employer must make. Contributions will be allocated to participants based on a formula set by the employer.
Money Purchase Plan
Similar to a profit sharing plan, except money purchase plans have required contributions. Annually, the employer must contribute to each participant the amount specified in the plan document. Again, the plan consists only of employer contributions.
A 401(k) plan has all the features of a profit sharing plan plus the plan permits employees to make contributions from their paychecks, on a pre-tax basis. The addition of employee contributions gives the employer another option for allocating the employer's contribution. The employer may make a "Matching" contribution, an amount based on the percentage contributed by employees. 401(k) plans are the most popular type of qualified plan.
Defined Benefit Plan
A plan that promises each participant a specified benefit at retirement. Employer contributions must be sufficient to fund the future benefit.
Cash Balance Plan
A type of defined benefit plan in which the participant's benefit is based on an account balance that is hypothetical and determined similarly to balances in defined contribution plans.
An Employee Stock Ownership Plan is a qualified defined contribution plan that is a stock bonus plan. An ESOP must be designed to invest primarily in qualifying employer securities as defined by IRC section 4975(e)(8) and meet certain requirements of the Code and regulations. The IRS and Department of Labor share jurisdiction over some ESOP features.
SIMPLE IRA Plan
A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up plan for small employers.
A 403(b) plan is a retirement plan for certain employees of public schools, employees of certain Code §501(c)(3) tax-exempt organizations and certain ministers. A 403(b) plan allows employees to contribute to the plan. The employer may also make contributions. 403(b) plans are also called tax-sheltered annuity plans.
457(b) Governmental Plan
A plan maintained by a state or local government and any of their agencies or instrumentalities. Governmental 457(b) plans must be funded and held in trust for the exclusive benefit of participants. Employee and employer contributions are permitted.
457(b) Tax-Exempt Plan
A plan maintained by a non-governmental tax exempt entity under IRC §501, except for churches and church-controlled organizations. Participation must be limited to a select group of management or highly compensated employees. The plan must do so to avoid being subject to the funding requirements under ERISA. Code Section 457 expressly prohibits the funding of 457(b) plans maintained by tax-exempt organizations. This type of plan is also known as a "Top Hat" plan.
Nonqualified Deferred Compensation Plan (NQDC)
An NQDC plan defers compensation that workers earn in one year, but that is paid in a future year. The objective is to defer the payment of tax and/or to defer it to such time that the worker is expected to be in a lower tax bracket. NQDC plans provide executives with substantial retirement benefits that cannot be achieved in qualified plans. The most common arrangements are life insurance plans, excess-benefit plans, top-hat plans, severance plans, deferred bonuses, vested trusts, rabbi trusts, secular trusts, stock options, phantom stock, and golden parachutes.
What incentives do my employees have to participate in a 401(k) plan?
High contribution limits so you and your employees can set aside large amounts for retirement.
“Catch-up" rules that allow employees aged 50 and over to set aside additional contributions.
A tax credit for certain low-and moderate-income individuals (including self-employed) who make contributions to their plans (“Saver’s Credit”). The amount of the credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent, depending on the participant’s adjusted gross income.
A Roth program can be added to a 401(k) plan to allow participants to make after-tax contributions into separate accounts, providing an additional way to save for retirement. Distributions upon death or disability or after age 59½ from Roth accounts held for 5 years, including earnings, are generally tax-free.
As an employer, must I allow my part-time employees to participate in our plan?
Part-time employees cannot be excluded just because they are "part-time." Any employee that satisfies the eligibility requirements established by the employer must be permitted to participate. The IRS permits an employer to exclude any employee that does not work 1,000 hours during the year, which may have the affect of excluding some part-time and even full-time employees. If in any year, a part-time employee completes 1,000 hours, they become a participant. The employee remains a participant from that point forward, regardless of the number of hours worked in subsequent years. This pertains to "participation" only and not to the participant's right to receive an employer contribution.
What is a Fiduciary?
A Fiduciary is anyone who manages, controls, or uses discretion in administering a qualified retirement plan. Many of the actions needed to operate a plan involve fiduciary decisions. This is true whether or not you hire someone to manage the plan for you, or mange the plan yourself. While there are some exceptions, a hired entity is a plan fiduciary to the extent of their discretion or control. Hiring someone to perform fiduciary functions is itself a fiduciary act. Thus, fiduciary status is based on the functions performed for the plan, not the title of "fiduciary." An employer is always a fiduciary.
What is the difference between a 401(a) plan and a 401(k) plan?
A plan that consists only of employer contributions is often referred to as a 401(a) plan, such as a profit sharing plan, money purchase plan, or an employee stock ownership plan. However, any qualified plan is a 401(a) plan, including a 401(k) plan. The term 401(k) means "employee" contributions are permitted in addition to any "employer" contributions.
What is the difference between a Defined Contribution plan and a Defined Benefit plan?
Defined contribution plans are employer-established plans in which employers and/or employees contribute discretionary amounts to employees’ individual accounts under the plan. At retirement, an employee receives the accumulated contributions plus earnings (or minus losses) on the invested contributions.
Defined benefit plans promise a specified benefit at retirement, for example, $1,000 a month. The amount of the benefit is often based on a set percentage of pay multiplied by the number of years the employee worked for the employer offering the plan. Employer contributions must be sufficient to fund promised benefits.
What is a governmental plan?
Under Code section 414(d), a governmental plan is a plan established and maintained for the employees of:
the United States or its agency or instrumentality
a state or political subdivision, or its agency or instrumentality
an Indian tribal government or its subdivision, or its agency or instrumentality (participants must substantially perform services essential to governmental functions rather than commercial activities.)
What type of plan can a governmental entity establish?
Plan type is determined by the type of governmental entity. For employee deferral purposes, a governmental entity will be permitted to sponsor either a 403(b) tax-sheltered annuity plan or a 457(b) deferred compensation plan. Some entities may also sponsor profit sharing or money purchase plans.