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Pension Plans
QUALIFIED RETIREMENT PLANS
401(k) Retirement Plan
The 401(k) plan is a defined contribution retirement plan suitable for any size business with employees. For programs with employer matching, there must be at least one non-highly compensated employee. A 401(k) plan can be very cost-effective because it can allow employee contributions, which may reduce the amount of funds the employer contributes.
Contributions are made in three different ways to a 401(k) retirement plan.
1) Employer profit sharing contributions.
2) Employee salary deferrals.
3) Employer matching contributions.
The employer profit sharing and matching contributions are both optional and at the discretion of the employer. Employee salary deferrals are optional and at the discretion of the employee. Taxes on employee salary deferrals are deferred until the money is withdrawn from the plan. Amounts generally cannot be withdrawn before age 59 1/2 or termination of employment.
Generally the maximum amount of funds the employer may contribute on an annual basis is 15% of the total compensation of the plan's participants. The maximum allocation to any one participant from employer contributions and salary deferrals combined is the lesser of $30,000 or 25% of their compensation. The maximum pre-tax salary deferral an individual may make for 1994 was $9,240 and is adjusted each year for inflation.
If an employee were to defer the maximum amount of $9,240, the maximum the employer could contribute on behalf of the employee would be $20,760 resulting in the total maximum allocation of $30,000. The employee would need annual compensation of $120,000 or more in order to qualify for a $30,000 annual allocation. It may be necessary under certain circumstances to reduce a highly compensated employees' deferral to meet various non-discrimination requirements. In applying all of the above qualifier retirement plan rules and in the sections below, only $150,000 of compensation may generally be taken into account.
SIMPLIFIED EMPLOYEE PENSION PLANS
Simplified employee pension plans, commonly referred to as "SEP"s are retirements plans designed for self-employed individuals or small businesses. Their popularity is due to the fact that they offer an effective way to shelter retirement funds from taxes while at the same time requiring very little in the way of administrative paperwork or expense.
SEPs permit employers to make tax-deductible contributions to their employees' Individual Retirement Accounts (IRA). The SAR-SEP (Salary Reduction SEP) allows employees to make contributions to their own accounts through salary deferrals (elective deferrals). In order to qualify for a SAR-SEP plan an employer must have had 25 or fewer employees in the previous year. In addition, at least 50 percent of the employees must participate in the plan each year.
There are limits to how much an employer and/or employee may contribute to a SEP or SAR-SEP. For the SEP the maximum contribution on an annual basis is fifteen percent of compensation with a maximum dollar limit of $30,000 per employee. The employer must contribute the same percentage of salary to each employee.
The SAR-SEP limits employee deferrals to $9,240 for 1994, which is indexed each year. If the company has both an SEP and a SAR-SEP the total maximum contribution is the lesser of $30,000 or fifteen percent of compensation, subject to other limitations.
PROFIT SHARING PLAN
The profit sharing plan is a defined contribution retirement plan that is suitable for any size business. Contributions can be made at the discretion of the employer.
The maximum an employer may contribute is fifteen percent of the total compensation of the plan's participants. The maximum any one participant may receive is the lesser of $30,000 or 25% of their compensation.
DEFINED BENEFIT RETIREMENT PLAN
A defined benefit plan is a tax-qualified retirement plan that may allow an employer to make larger contributions than 2other retirement plans. It may be well suited for an employer who desires to shelter the maximum amount allowed. Annual contributions, which are actuarially determined, are required. A company with one or more principal employees who are within fifteen years of retirement may generally be a good candidate for this type of plan.
The annual contribution is determined by an actuary at the inception of the plan. It is the responsibility of the actuary to calculate the contribution necessary to provide the specified retirement benefits given a set of assumptions. Once the contribution level has been set it is fixed and the employer must make these contributions regardless of profits in any specific year. Because of this, a company should have a history of strong, steady cash flow before making a commitment to a defined benefit plan.
The maximum benefit that a defined benefit plan can provide is the lessor of 100 percent of the employee's annual compensation or an amount determined by the Secretary of the Treasury, which was $118,737 for 1994. This amount is indexed for inflation each year.
As a result of the complex nature of the defined benefit plan the start up and administration expenses are relatively high. A defined benefit plan can also be combined with a defined contribution plan to allow an employer more flexibility.
The above information on qualified retirement plans is general in nature and meant only to provide an overview. Before making any decisions, a careful legal and tax analysis should be made with the assistance of competent legal and tax advisors.
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