James P. Schnell, BridgeTower Media Newswires
Both existing and start-up companies routinely seek to analyze whether they should offer a retirement plan and in doing so look to gain an understanding of what options are available and which best suit their current situation, budget or priorities.
Retirement Plans are generally divided into two main categories: Defined Benefit Pension Plan or a Defined Contribution Retirement Plan.
A defined benefit pension plan is a type of pension plan in which an employer promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee’s earnings history, tenure of service and age, rather than depending directly on individual investment returns.
A defined contribution plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis.
Within the plan, individual accounts are set up for participants and benefits are based on the amounts credited to these accounts; through employee contributions and, if applicable, employer-match or profit-sharing contributions. In addition, the accounts accumulate investment earnings on the money in the account, whose future benefits fluctuate on the basis of investment earnings
The most prolific type of retirement plan utilized by the business community in the modern era are the defined contribution plans. The following types of plans, in order of their administrative complexity and deferral options, fall under this category:
Individual Retirement Accounts — Easiest plan to engage on an individualized basis with a deferral limit of $5,500 for 2016 ($6,500 if age 50 or over by end of year).
Simple IRAs — Often regarded as the most economically efficient administrative plan solution where limited funds are available for retirement and an employer has fewer than 100 employees. Employee deferral limit is $12,500 for 2016 ($3,000 additional if age 50 or over). Limited plan administration, no bonding requirements, no permanency requirement and not subject to ERISA Title I. Investment responsibility with employee only. Required employer contribution: 100 percent of employee deferrals up to 3 percent or 2 percent of compensation.
SEP (Simplified Employee Pension) — A SEP Plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. Contribution limit is the lesser of 25 percent of compensation or $53,000.
Limited plan administration, no bonding requirements, no permanency requirement. May be established as late as due date of employer’s tax return. Must cover all employees who have attained age 21, worked for employer in any three of five preceding years and earned $600 during current year.
401(k)/Profit Sharing Plans — Qualified Plan, Subject to IRC 401(a), reporting and requirements of ERISA Title I, Form 5500 filing, bonding and IRC 404 Fiduciary duties all required. Employee deferral limit of $18,000 for 2016 ($6,000 additional if age 50 or over). Employer-match and profit-sharing options available which may provide up to $53,000 total contribution ($59,000 if age 50 or over).
Cash Balance Plan — This is the only Defined Benefit Plan type addressed in this article.
A Cash Balance Plan maintains hypothetical individual employee accounts and contributions, however the actual annual calculations and funding ranges utilize the same processes found within a traditional pension plan (see defined benefit pension plan definition above). This option has the highest level of employer commitment and most complex administration requirements of any plan discussed above, but in return offers incredibly high contribution ranges which small business owners may utilize (and deduct for tax purposes) on an annual basis.
The plan calculations and results are mostly dependent upon the ownership and employee census population metrics, which means each situation yields a different and specific result. The resulting calculations may easily allow owners to go from the $53,000 qualified plan limits shown above to upwards of $200,000-$250,000 (plus) total contributions while only requiring a very nominal contribution to the employee pool.
In summary, there are many different types of retirement plan options available to employers. They offer a range of mandatory administrative requirements and deferral/contribution limits.
Employers should re-visit their existing retirement plan offerings every few years to assess it is meeting the full needs of both the employees and ownership group and if not, what other relevant options may better suit their needs.
—————
James P. Schnell, CPA/ABV, CVA is a Tax & Business Valuation Partner at Mengel, Metzger, Barr & Co LLP.
