Employer Retirement Plans: Maximizing Benefits and Tax Advantages

1. Initial steps: • Gather relevant facts • Identify employer goals and objectives • Select plan features that meet objectives

2. Advantages for the employer: • Help employees with retirement savings • Tax deferral for owners and highly compensated employees • Help recruit, reward, retain, and retire employees • Encourage productivity • Discourage collective bargaining

3. Employers may use qualified or nonqualified plans to meet their planning objectives • Qualified plans – enjoy tax advantages but must meet strict IRS rules to ‘qualify’ for those advantages • Nonqualified plans – allow employers more flexibility in plan design, but offer far fewer tax advantages than qualified plans

4. A nonqualified plan allows an employer to provide benefits for key employees that … • do not have to be duplicated among rank and file employees • can exceed the dollar limits imposed under qualified plans • can be custom tailored to meet needs of select executives or key employees

5. With a nonqualified plan, an employer can: • Recruit a key employee when matching or exceeding benefits of their current employer would make offered benefits exceed benefit levels given other employees • Reward the individual or group that makes a substantial contribution to the success of the business • Enable a business owner to use company earnings in ways that reduce or defer taxes and accumulate wealth

6. Tax Advantages of Qualified Plans • Plan contributions (employer contributions and employee salary reduction contributions) - tax deductible for employer - tax deferred for employee • Earnings on plan investments accumulate tax deferred • Some lump sum distributions may qualify for 10 year averaging

7. Types of Qualified Plans Defined Contribution - contribution to plan by employer or employee is specified, but value of plan at retirement is not - employee bears investment risk Defined Benefit - benefit to be paid to employee at retirement is specified - employer responsible for meeting investment goals

8. Defined Contribution Plans Two Broad Types • Money Purchase Pension Plan • Employer must contribute stated percentage of employee compensation to account each year (up to 25%) • Profit Sharing Plan • Employer determines amount of contribution, often based on company profit • Contributions must be made on nondiscriminatory basis, often based on compensation • Allocation can be weighted to favor older workers

9. Defined Benefit Plans • Plans funded on actuarial basis • Funding amount greater for older employees • Makes defined benefit plans attractive to professionals or closely held business owners

10. In recent years, due to factors such as rising cost of providing benefits and more frequent job change among employees, the number of Defined Benefit plans has declined while the number of Defined Contribution plans has grown

11. Not all employees value retirement benefits: • Younger employees • Transient employees • Low-paid employees Plan design must • Maximize benefits for those who want them • Be perceived as providing valued benefits

12. Which plan should an employer select?

13. Which plan should an employer select? A plan that matches, as best as possible, employer goals and qualified plan characteristics Consider how employers might achieve the following objectives

14. 1. Employer wants to maximize the portion of plan costs that benefit highly-compensated employees.

15. Maximize the portion of plan costs that benefit highly-compensated employees. - Defined benefit plans - Service based contribution or benefit formulas - Age weighting and cross-testing - Combine defined benefit and defined contribution plans - 401(k) plans - Social Security integration

16. 2. Provide a savings medium that employees perceive as valuable

17. Provide a savings medium that employees perceive as valuable - Defined contribution plans - Cash balance plans - Plans with employee participation

18. Provide adequate replacement income for each employee’s retirement - Defined benefit plan

19. 4. Create an incentive for employees to maximize performance • Profit sharing plan • ESOP/stock bonus plan • Any other defined contribution or cash balance plan

20. Minimize turnover • Defined benefit plan • Graduated vesting

21. Encourage retirement - Defined benefit plan

22. 7. Maximize employer contribution flexibility • Qualified profit sharing plans • SEPs

23. Application Exercise Software Solutions, Inc. is a 5 year old company that develops computer programs for clients. Jeff, the owner, is 35; average age of the 20 employees is 31. Jeff wants a plan that will encourage his employees to be more productive, but will also help reduce turnover. He’s also concerned about the cash flow of his young company. Which plan (s) should Jeff consider?

24. Application Exercise • profit share or ESOP -would encourage employees to produce more since these plans are typically based on company profit -would give Jeff discretion in contributions • gradual vesting -Could help reduce employee turnover -Funds forfeited by non-vested, departing employees could be used to benefit remaining employees