Joné E. Liuzza, ERPA, QPA, QKA Director of TPA Services
Many years ago, along with the birth of ERISA (Employee Retirement Income Security Act), a famous “rock” group posed a great question with the song lyrics “What’s The World Coming To?” With all that’s happening today, the question may now be apropos more than ever before.
An age-old dilemma for professional corporations and other businesses with multiple owners of varying ages is how to structure compensation to include the currently taxable income, discretionary, and tax-deferred retirement components to achieve for each owner a “total compensation package” in the desired proportion.
Currently, taxable components don’t present a problem. Complicating matters are the tax-deferred components, especially the “qualified retirement plan.” After all, doesn’t retirement plan law require all participants, including owners, to be treated alike?
Not really…or more emphatically, absolutely not!
In considering “what kind of retirement plan” to implement, the most neglected consideration is something known as “plan design.” The truth is, designing a retirement plan is akin to drafting plans for a dream home. Actually, the “cost” of poor design for either can be enormous. A dream home that involves $750,000 pales in comparison to the creation of a $1.5 million retirement account.
“Plan design” can deliver hundreds of thousands of dollars in additional retirement benefits. Stated differently, “plan design” is the only tool that can maximize available tax savings. Plan design can eliminate the dilemma of how to individualize total compensation packages for partners and executives of varying ages and varying wages. Plan design can produce unique individualized results.
Plan design is the opposite of generic. Mass producers of retirement plans utilize generics to accommodate the “generic market,” as well as to attract business from unsuspecting clientele. All too often, “investment dollars” are the target.
A number of plan choices and plan design techniques can differentiate the unique from the generic. In the trade, terms like cross-testing and cash balance describe the uniqueness of various plan designs. Total compensation packaging and tax-favored benefit optimization describe the outcome. Use of any one of these techniques can often result in hundreds of thousands of dollars of “retirement savings difference” over a normal working career.
Unlike other types of profit sharing and 401(k) plans, a “cross-tested” plan permits plan sponsors to contribute different amounts and different percentages of pay to the various participating employees, including owners. A simple and effective way to individualize each owner/executive’s retirement plan contribution is to contribute different desired amounts to each respective owner/executive’s account. Individual A may desire the maximum (i.e. in 2022—$61,000 if profit sharing; or $67,500 if 401(k)/PS and the individual is age 50 or over). Conversely, individual B desires a smaller contribution and a larger taxable compensation. Yet, the sum of retirement plan contributions plus taxable compensation can equal the same for both.
A similar result can occur with “Cash Balance Plan” design. Different levels of contributions may be made to individualize the contributions for different individuals, but the maximum annual contribution on behalf of an individual is not limited to $61,000 or $67,500. Depending upon the age and compensation of the individual participant, the deductible annual contribution can be as much as $100,000, or even $200,000 per person.
Assume “A” and “B” are both employed by that same corporation, and both are earning a “total compensation package” of $350,000 annually. “A” has three children attending Ivy League Schools and needs every dollar available for tuition, while “B” has no children and a modest lifestyle. A cash balance plan would permit the company, on behalf of “A,” to contribute $50,000 annually for retirement and pay him $300,000 taxable. “B” on the other hand could receive just $175,000 taxable and receive a contribution in his cash balance plan account of $175,000. The “total compensation package” for each would total the $350,000 available. “Age” is a variable that can affect results in a cash balance plan.
“What’s The World Coming To?” With regard to compensation structures, tax strategies, retirement planning, and other financial issues impacting short- and long-term goals of business executives and professionals, there seems to emerge a never-ending array of flexible options to meet their unique personal objectives. What The World Is Coming To – is more and more flexibility in retirement plan design to encourage individuals across the spectrum to “save more” for the future. By now, everyone knows that Social Security and other government-subsidized programs will fall woefully short of providing enough for a dignified retirement.
Creative qualified plan design represents an important component in overall compensation planning for key members within a company. Contact ACG to find out what type of qualified plan design is right for you!