Company Retirement Plans

The decision to implement a retirement plan is one of the smartest choices that a business can make. It can give you and your employees the opportunity to save for your future while enjoying substantial tax savings today. The benefit to a business owner is twofold. First, as a business owner, a company-sponsored retirement plan can help you attract and retain your most valuable business assets – quality employees. Secondly, as a participant, a retirement plan will allow you to save for your own retirement.

Simplified Employee Pension

A Simplified Employee Pension Plan, or SEP, may be an ideal choice for self-employed individuals or small businesses because it is very easy to administer. A SEP can provide many of the benefits of a standard retirement plan, and is easy to establish and maintain. A SEP can also give you more limited responsibility as an employer. Each of your employees is responsible for his or her own SEP-IRA account. This means less administrative hassle for you, and also there is a comparatively small amount of government reporting. The typical candidates for establishing SEP accounts are sole proprietors, consultants, and small businesses — especially those with high turnover rates or younger employees.

How a SEP works 

A SEP plan allows you to save up to 13.0435% of your net earnings each year. The annual maximum is $22,173. All of your contributions into a SEP plan are tax deductible. If you have employees, they must be included in the plan as well. You must contribute the same percentage of their earnings as you do personally. All employees who meet the following criteria must be included in the plan:

• Age 21 or higher
• Employed by you for any amount of time during three of the last five years, and
• Received at least $450 of compensation from you in the current year

Profit Sharing & Money Purchase

Qualified Retirement Plans like Profit Sharing and Money Purchase Plans are types of retirement plans that are funded by the employer. They allow employers to contribute to an employee’s account, while offering them business tax deductions and tax-deferred savings.

How the Profit Sharing Plan works 

Profit Sharing Plans are designed for companies with fluctuating or uncertain profits. These plans can be established by sole proprietors, partnerships, or corporations. Companies can make a discretionary contribution of up to 15% of an eligible employee’s total compensation. In a Profit Sharing Plan, the employer has the flexibility to determine the contribution amount each year. Contributions do not have to be dependent on profits. Contributions by the employer are tax deductible as a business expense and are not treated as taxable income to the employee.

How the Money Purchase Plan works

In Money Purchase Plans, the employer’s contribution is mandatory. The contributions are usually based on each employee’s compensation. The employer sets specific eligibility and vesting requirements, and contributions can be as high as 25% of total compensation or $30,000 whichever is lower. Money Purchase Plans are less flexible than Profit Sharing Plans because contributions must be made even if the company has no profits.

Profit Sharing & Money Purchase Combination

Many companies choose to implement both of these types of plans in conjunction with one another. This allows for a greater total contribution percentage. By combining these two types of plans, an employer can effectively contribute 25%, up to $30,000. A typical example of how this works is an employer making a 10% mandatory Money Purchase contribution, and a discretionary 15% contribution into the Profit Sharing Plan. This type of approach offers some flexibility while maximizing the potential contribution percentage.

SIMPLE IRA Plan

The Savings Incentive Match Plan for Employees-IRA replaced the SARSEP-IRA for plans established after January 1, 1997. A SIMPLE-IRA is specifically designed for companies with less than 100 employees. Companies with more than 100 employees cannot use the SIMPLE Plan. Additionally, companies cannot maintain or contribute into any other type of retirement plan. In a SIMPLE Plan, contributions are made by both employer and employee. Contributions are made on a pre-tax basis, thus giving added tax benefits to the plan’s participants.

How a SIMPLE Plan works 

Employees can contribute 100% of their earned income up to a maximum of $6,000 per year into a SIMPLE Plan. There is a mandatory employer match. This can be either a 100% match on the first 3% of employees’ total compensation for all eligible employees who elect to participate in the plan, or a 2% match on total employee compensation regardless of employee participation. A SIMPLE plan can work great for a family-run business. A husband and wife business can put in up to $24,000 combined depending on their compensation. A SIMPLE Plan offers you and your employees the opportunity to contribute money on a pre-tax basis into a retirement account. SIMPLE Plans are easy to set up and administer, and have minimal administrative costs.

401(k) Plan

The 401(k) Plan is probably the most widely-used company retirement plan. The term 401(k) refers to the section of the Internal Revenue Code which permits employees to defer part of their income into a company-sponsored retirement plan. A 401(k) Plan is a great way to attract and retain employees. 401(k) Plans allow for contributions by both the employee and employer. A profit-sharing contribution can also be made by the employer. This type of contribution is at the discretion of the company. A matching contribution may also be made by the employer on behalf of the employees. This type of contribution is mandatory if that option is selected as a plan feature.

How a 401(k) Plan works

The flexibility of a 401(k) Plan allows companies to select plan features to achieve specific goals for your company and your employees. A plan must set specific eligibility requirements and vesting schedules. A 401(k) Plan may require that employees be age 21 and/or completed at least one year of employment with the company in order to participate. If the plan calls for immediate vesting, two years of employment may be required prior to becoming eligible.

Vesting is another term for ownership of the account balance and is determined mainly by the source of the funds. Contributions that employees make are always 100% vested, meaning that they always own all of the money that they contribute into the plan. Contributions that employer’s make may follow a schedule in which the vesting percentage increases with each year of employment. The maximum number of years before an employee is fully vested is seven. This is at the employer’s discretion and can be less than seven years.

The maximum amount of annual contributions into a 401(k) Plan is 15% of an employee’s compensation or $10,000, whichever is less. Employee contributions and company matching contributions cannot be more than 25% of an employee’s total compensation. Employers can alter their matching contributions from year to year.

Executive Deferred Compensation

Nonqualified deferred compensation arrangements are all compensation arrangements in which the employee defers reporting the income, but which are not “qualified” under the Internal Revenue Code. Qualified arrangements, an example of which is a 401(k) plan, allow for immediate employer deductions of amounts set aside for employees, despite the employees not having to take those amounts into income, as well as tax free “inside build up” of income accrued on the assets set aside for the employees. In other words, qualified plans allow a radical mismatch of the timing of income to the employee and a deduction to the employer. Nonqualified plans, in contrast, allow for half a loaf, deferral of income by the employee, but no immediate deduction to the sponsoring company.

Qualified plans entail a considerable compliance burden on the part of the employers and are subject to both dollar limitations, that is to say, limitations on how much the people running the company can grab, and so called “nondiscrimination” rules, which are also designed to insure that the benefits of the deferred plan are not skewed toward highly compensated employees.

Nonqualified deferred compensation plans are, in contrast, cheaper to set up and administer than qualified plans, and are subject to no limitations relating to either the amount of compensation or who can or cannot participate. (Except, generally speaking, the benefits cannot be made available company-wide. Company-wide deferred compensation arrangements must be administered as qualified plans). The disadvantages consist of, first, foregoing the tax benefits described above, and, second, that, generally speaking, the funds “set aside” for the benefit of the employee are subject to the claims of the creditors of the employer. In other words, retirement benefits accumulated under a nonqualified plan are not as safe as benefits set aside in a qualified plan.

The touchstone of any nonqualified deferred compensation plan is the issue of “constructive receipt.” If cash, stock or other property is “constructively received” by an employee, that employee has to pay taxes on the amount deemed received. Nonqualified deferred compensation plans that work as designed allow the employee in question to accrue a benefit, but not be deemed to have constructively received that benefit for tax purposes.

Nonqualified deferred compensation plans vary because there is no one way to design around the constructive receipt doctrine, and each employee and each company has different needs and limitations. Such plans are often paired with qualified plans, so that top management is in the same boat as lower paid employees for purposes of a qualified plan or plans sponsored by the company, but then enjoys additional, less highly tax favored compensation, in the form of either stock options or a promise to receive, at some point, stock, stock options or cash. In all events, the promise must be unsecured, that is to say the beneficiary of the promise is left to the vicissitudes of the company’s fortune. As between the employee and third party creditors, third party creditors will enjoy equal or superior status to the executive’s deferred compensation claim. Note, however, that as between the employee and the company, the company can agree to set aside funds so that, short of bankruptcy, receivership or attachment by creditors, the company will have no ability to divert the assets pledged to the employee under the deferred compensation plan. This arrangement may involve the establishment of a trust, such as a “rabbi trust,” so named because the first ruling issued by the IRS approving this arrangement involved a deferred compensation arrangement between a rabbi and his congregation.

There is much to be said about nonqualified deferred compensation plans, but all of it depends upon the resources and needs of each company and of the employee or set of employees considering such a plan.

That being said, three illustrative plans are as follows:

The company annually credits a fictional account on behalf of an executive, with the payment measured against the company’s performance for that year. The accrued benefit, with or without an interest factor, would be paid to the executive either in a lump sum or over a period of years, starting on either a date certain in the future, or the date of that employee’s termination, retirement or death. The executive has income, and the company has a compensation deduction when the money is given to the executive.

The company issues stock to the executive. The stock is:

1.  The company annually credits a fictional account on behalf of an executive, with the payment measured against the company’s performance for that year. The accrued benefit, with or without an interest factor, would be paid to the executive either in a lump sum or over a period of years, starting on either a date certain in the future, or the date of that employee’s termination, retirement or death. The executive has income, and the company has a compensation deduction when the money is given to the executive.

2.  The company issues stock to the executive. The stock is (1) subject to restrictions on assignability; and (2) subject to forfeiture in the event of some undesirable happening, such as the executive leaving the firm before a prescribed number of years.

The executive has income (and the employer a deduction) when the restrictions lapse.

3.  The company issues options to the executive which entitle the executive to purchase stock in the company. Although such an arrangement is not “qualified” in the sense discussed above, there are two kinds of stock options, one of which is confusingly referred to as a qualified stock option and the other of which is known as a nonqualified stock option. The formal name for qualified stock options is incentive stock options, or ISO’s. ISO’s are, from the executive’s point of view, taxed more favorably than are nonqualified options. There are lots of nonqualified options and lots of ISO’s in the world, because there are advantages to both.