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Midwest Pension Actuaries offers full service design and administration of these Qualified Plans.
Profit Sharing Plans
In a traditional allocation, employer contributions are divided among the eligible employees on a comp to comp basis. In other words, each employee receives his or her portion of the contribution in the same ratio as his or her compensation in relation to the total eligible compensation of the company. For example: Employee A has compensation of $10,000. The total eligible payroll at the company is $100,000. Employee A would receive 10% of the dollars contributed to the plan for that year.
In this type of Plan, the employer segregates the eligible employees into “non-discriminatory” categories (i.e.: job description, title, hourly vs. salaried, etc.) and designates different contribution rates for each group.
Because of the potential for discrimination in favor of “Highly Compensated Employees” this type of Plan is required to perform special tests each year to ensure that the contributions do not violate IRC Sec. 401(a)(4) and 410(b) non-discrimination regulations. If the Plan does not pass these tests, the contribution rates for some/all groups must be adjusted. Also effective beginning with the 2002 plan year, in most cases, each NHC cannot receive a contribution that is less than 5% of salary regardless of the results of the non-discrimination tests.
This type of Plan is normally designed to favor the highly compensated employees or older employees. However, it can be designed to favor any group of employees assuming the annual “non-discrimination” requirements are satisfied.
This type of allocation method is integrated with an overall retirement scenario that includes Social Security; this combination is called “permitted disparity”. By providing for permitted disparity in it’s qualified retirement plan, the employer gets the benefit of it’s Social Security Tax payments.
Under an Integrated Profit Sharing Plan compensation is broken out into two parts; the amount above the integration level (excess compensation), and the amount below the integration level (base compensation). Usually the integration level is the Social Security Taxable Wage Base in effect for the applicable year. The employer is permitted to “offset” their contribution to Social Security by applying a lower contribution percentage to the base compensation (i.e.: the base percentage) and a higher contribution percentage to the excess compensation (i.e.: the excess percentage). In other words, employees with compensation above the Social Security wage base are allowed an additional contribution on that amount. This shifts the allocation toward the higher paid employees.
An age-weighted profit sharing plan uses both age and compensation as a basis for allocating employer contributions among plan participants. Age and compensation are used as factors to determine the amount of the employer contribution. Because age is a factor, this type of plan favors older employees who have fewer years to accumulate sufficient funds for retirement.
401(k) Plans
A 401(k) plan is a profit sharing plan with a 401(k) attachment. The 401(k) attachment allows participants to defer money out of their paychecks into the plan. The employee’s deferrals are tax deferred allowing for a tax savings in the current year. The deferrals are segregated to a participant’s account and grow tax deferred until retirement.
The employer may also make a contribution to the participant’s account. This contribution can be in the form of a profit sharing contribution or a match. A match is a contribution from the employer equal to a pre defined percentage of the employee deferral.
401(k) have become the most popular form of employer sponsored qualified retirement plan. Two key reasons for this is the ability of an employee to save money themselves and save immediate taxes at the same time as well as an employer’s ability to add contributions for employees on a very flexible basis.
401(k) plans can be combined with any other type of qualified plan to help design the ideal plan for your company.
A safe harbor 401(k) is the same as a traditional 401(k) with one very important difference. In a safe harbor plan the employer is required to make a minimum profit sharing or matching contribution to the plan in exchange for less testing requirements. These plans allow more contribution options for highly compensated employees in plans that traditionally fail testing requirements.
An individual can take advantage of the 401(k) provisions in a profit sharing plan to allow for additional contributions.
Defined Benefit Plans
A defined benefit plan is one in which the monthly retirement benefit to be provided at retirement is defined in the plan. Benefits are usually defined in terms of the participant’s compensation, service, and/or participation and are expressed in terms of a monthly benefit commencing at the participant’s normal retirement age (as defined in the plan). For example, a plan that entitles a participant to a monthly pension for his or her life or equal to a certain percentage of monthly compensation is a defined benefit pension plan.
In many cases, the actual payment of the benefit is in a form other than the plan’s normal annuity form. These other forms of benefits are called alternate forms and are actuarially equivalent to the normal form of benefit, an example is a lump sum benefit payment of the actuarial present value of the participant’s accrued benefit.
Because there is an annual minimum funding that is required to be made to a Defined Benefit Plan an employer has much less flexibility toward the annual contribution. For this same reason it can allow for much greater contribution than you will find in a Defined Contribution plan.
A defined benefit plan can allow for contributions far exceeding the limitations of profit sharing plans. This makes it an ideal plan for older employees wishing to save large amounts quickly, or for employers wishing to establish a secure traditional retirement plan for their employees.
A cash balance plan is a defined benefit plan that simulates a defined contribution plan. Benefits are defined by a formula similar to the allocation formulas in a profit sharing plan with account balances credited with a fixed rate of return and converted to a monthly pension benefit at retirement.
This monthly pension benefit is funded as a traditional defined benefit plan. As with a traditional defined benefit plan, cash balance plans allow the employer to exceed the limitations on contributions seen in profit sharing plans.