Decisions, Decisions ... A Comparison of Small Business Retirement Plans

By J. Saunders Wiggins, CFP®, AIF®

J. Saunders Wiggins, CFP®, AIF®

J. Saunders Wiggins, CFP®, AIF® CEO/President

 Offering a retirement plan to your employees is one of the best decisions your company can make. Qualified retirement plans like 401(k) plans offer tax benefits to your employees and your business while also serving as a powerful employee recruiting and retention tool.

But deciding to offer a retirement plan is just the first step. Next, you need to determine what type of plan you’re going to offer. There is a wide range of different kinds of retirement plans — choosing the right one will depend on your company’s specific goals and objectives.

Let’s Start with a 401(k) Plan

The 401(k) plan is perhaps the most popular type of retirement plan among small- and mid-sized firms today. A 401(k) plan is a defined contribution (DC) plan that enables your employees to defer a portion of their salary. This reduces their current taxes while also enabling them to save money for retirement.

In 2016, employees can defer up to $18,000, or up to $24,000 if they are age 50 or over.

There are a number of ways to structure the 401(k): employee deferral only, company match, and in some cases a “safe harbor” 401(k) plan is worth considering.

Under a non-safe harbor plan, your company can match employees’ contributions to their 401(k) accounts at whatever percentage you choose — for example, on a dollar-for-dollar basis or maybe 50 cents or 25 cents on the dollar.

A non-safe harbor plan is subject to the ADP or the Actual Deferral Percentage test. In general, this means that highly compensated individuals may be limited in how much they can contribute to their 401(k) if other non-highly compensated individuals are not contributing enough.

Generally, safe harbor 401(k) plans are structured in one of two methods, either a Match or a 3% non-elective contribution.  Both allow you to avoid the ADP test. Safe harbor “Match” 401(k)s require a formula of matching 100% of the first 3% deferred and 50% of the next 2% deferred by participating employees. The 3% non-elective contribution is not a match but is contributed to all eligible participants regardless of their deferral rate. Safe harbor matching and the 3% non-elective contribution is always 100% vested.

Want to Contribute More? Consider a Profit Sharing Plan

While the 401(k) contribution limit is $18,000 or $24,000, the total DC plan limit in 2016 is $53,000 or $59,000 for employees who are age 50 or over. Some owners and key employees might want to save more for retirement each year than the 401(k) limits, so how can the plan design be enhanced to achieve this?

One way is by offering a profit-sharing plan in addition to a 401(k) plan. With a profit-sharing plan, you can fill the “gap” between the 401(k) contribution limit and the DC plan contribution limit, thus contributing greater retirement savings for you and your employees.

Max Out Contributions With a Cash Balance Plan

In addition to DC plans like 401(k) and profit-sharing plans, you can also implement a defined benefit (DB) plan to enable even more tax favored retirement savings. Contribution limits for DB plans can exceed $150,000 per year.

One of the most popular DB plans is a cash balance plan. This type of plan is often used by business owners and highly compensated employees who want to sock away well in excess of the DC contribution limits each year for their retirement.

For example, suppose a successful, 55-year-old business owner is earning an annual salary of $500,000. However, he only needs about $300,000 a year to meet his family’s living expenses. His deferrals and contributions would total $59,000 via a 401(k) and profit-sharing plan and another $150,000 via a cash balance plan, thus saving $209,000 per year for retirement while also sheltering this income from current taxes.

What’s the Right Choice for Your Business?

So which of these types of retirement plans is the right choice for your company? The answer depends on several different factors.

First, do you or your key employees want to save more than the annual 401(k) contribution limits of $18,000 or $24,000? If so, you should consider adding a profit-sharing plan to your retirement plan offerings. And if you or your key employees want to save more than $53,000 or $59,000 per year, you should consider adding a cash balance plan to your offerings.

The main drawback to offering DB plans like the cash balance plan is the additional cost. A safe harbor 401(k) can be relatively inexpensive to set up and maintain — but once you get into plans with higher contribution limits, the cost and complexity also go up. In addition, contributions to cash balance plans are mandatory, not discretionary like they are with 401(k) and profit-sharing plans.

The Real Answer Is: It Depends

To truly build the best retirement plan for your company, you need a service-oriented partner like ACG who can design a custom retirement plan that achieves your goals. It is important to note that each plan desgin must pass applicable discriminisition tests.
Unlike many other firms, we’ll educate you on what your options truly are and offer you more than basic “off-the-shelf” options. This way, you’ll get the best result for you and your employees while saving on taxes.

Build a retirement plan that meets the needs of your business: contact a retirement plan specialist today. We’d love to learn about your business and help you make the best decisions — both for your business and your employees.

Are you aware of your options and responsibilities as a plan sponsor?

 

— Topics: 401(k), Retirement