Common Plan Types
When it comes to choosing the best retirement plan for your client, there are several options. Each has its own set of benefits and limitations.
The 401(k) is an employer-sponsored plan that allows employees to contribute to their accounts through salary-deferral. Depending on the plan design, these contributions can be made either pre-tax or post-tax (Roth). Earnings are accrued on a tax-deferred basis, meaning they are not taxed until they are withdrawn.
Employers can choose to match a percentage of employee’s contributions or make non-elective contributions for all employees regardless of whether they contribute or not. A profit sharing component may also be added to the plan design.
A profit sharing plan (also called a deferred profit-sharing plan or DPSP) allows business owners to share a portion of the company’s profits with their employees. All contributions are discretionary and are based on the company’s quarterly or annual earnings.
Profit sharing plans are available to businesses of all sizes. They offer a great deal of flexibility for owners who want to defer excess funds while giving employees a sense of ownership and loyalty.
There are three primary types of profit sharing plan.
In pro-rata plans, each employee receives the same percentage of compensation. This is ideal for small companies in which the owner has a much higher salary than the employees. Pro-rata plans help owners defer more funds, minimizes the amount of the contribution allocated to employee accounts, and still allows the plan to meet non-discrimination requirements.
Integrated plans use benefits payable under Social to offset the total contribution amount. This is best for employers who wish to allocate a larger portion of the profit sharing contribution to higher paid employees.
New comparability is one of the most flexible profit sharing options. It allows you to divide employees into objective non-discriminatory categories, each of which has a separate calculation formula.
These plans enable employers to allocate a larger portion of the contributions to older, more highly-compensated employees. They can be more complicated than the other options and require additional non-discrimination testing.
Cash Balance Plan
Cash balance pension plans are defined benefit plans that share some of the features of a defined contribution plan. Under this structure, employers credit each participant’s account with a pre-defined percentage of annual income plus interest.
Plan contributions are based on a set interest target. If the underlying portfolio out-performs this target, the plan sponsor keeps the gains. If, however, the portfolio doesn’t reach its target return in any given year, the plan sponsor must contribute additional funds.
This is an ideal type of plan for businesses with high profits looking for tax-deferred savings opportunities.