For a business, choosing the right retirement plan is one of its most important financial decisions because the plan must suit not only the employer’s immediate needs but also its financial and business profile. At SkyOak we have retirement plan specialist who can design and implement the right for your company and its employees.
A qualified plan is established by an employer to provide retirement benefits for its employees and their beneficiaries. A qualified plan may be a defined-benefit plan or a defined-contribution plan. Qualified plans allow the employer a tax deduction for contributions it makes to the plan, and employees typically do not pay taxes on plan assets until these assets are distributed; furthermore, earnings on qualified plan assets are tax deferred.
A qualified plan offers benefits to both employer and employees:
Benefits for Employers:
- Employers may receive a tax deduction for plan contributions.
- Employers are able to attract and retain high-quality employees. A qualified plan may be the tie-breaker that wins over a skilled person who is offered relatively similar compensation packages from different potential employers.
- Employers may be able to claim a tax credit for part of the ordinary and necessary costs of starting up the plan.
Benefits for Employees
- Employees are provided with a resource that can help with income replacement in retirement years.
- For plans that provide salary-deferral features, employees are able to defer paying taxes on a portion of their compensation until their retirement years, when their tax bracket may be lower.
- Some plans allow employees to borrow from the plan. The interest paid on the loan amount is credited to the employee’s account, unlike interest on loans obtained from financial institutions, which is paid to the financial institution.
In order for a plan to maintain its qualified status, it must operate in accordance with requirements as provided by the Internal Revenue Code (IRC), the Department of Labor (DOL) and the Employee Retirement Income Security Act (ERISA) of 1974. At SkyOak, we take an in-depth look at 401(k) plans, the rules surrounding them and how employees can best use them to their advantage.
Types of Qualified Plans
Defined Benefit Plans
We are seeing less of defined benefit plans established over the last decade but if it fits the criteria you and your company are looking for, Our Advisors at SkyOak can design and implement this strategy for your company.
Under a defined benefit plan, employees’ retirement benefits are predetermined by their compensation, years of service and age. For example, the plan may determine that upon retirement an employee will receive 1% of his or her average salary for the last five years of employment for every year of service with the employer. The plan may state this promised benefit as an exact dollar amount, such as $500 per month at retirement.
The employer will make contributions that, based on actuarial assumptions including projected growth of investments, are required to reach the predetermined retirement benefit. Should the performance of plan investments fall below the projected amount, the employer is required to make additional contributions to make up for the shortfall.
A defined contribution plan does not promise a specific amount of benefit at retirement like a defined benefit plan. Within a defined contribution plan, the contributions are invested on the employee’s behalf, and the benefits paid to employees are based on contributions and any earnings or losses. Employees or employers (or both) contribute to these plans. Typically, the contribution will be a percentage of compensation up to a certain dollar amount. Depending on the plan type, the contributions made by the employer may be mandatory or discretionary. For defined-contribution plans, employers are not required to make up for any losses on investments.
A defined-contribution plan can be a profit-sharing plan, an employee stock ownership plan (ESOP), a 401(k) plan or a money-purchase pension plan.
- Profit-Sharing or Stock-Bonus Plans
A profit-sharing plan is typically used for sharing profits from the business with employees, but an employer may make profit-sharing contributions regardless of whether the business had profits for the year. Contributions to the plan are usually discretionary, which means that the employer may choose not to contribute to the plan every year.
A stock-bonus plan is a type of profit sharing by which a corporation uses its own stock to make contributions and distributions. These plans, however, are not available to sole proprietorships and partnerships.
Profit-sharing and stock-bonus plans are suited for employers who are newly established and are unable to determine profit patterns or who want to have flexibility with making plan contributions.
A profit-sharing and stock-bonus plan may include a 401(k) plan feature.
- Money-Purchase Pension Plan
In general, an employer has more flexibility in contributing to a profit-sharing plan than to a money-purchase pension plan. Contributions to a money-purchase pension plan are fixed and are not based on business profits. For example, if according to the plan each participant will receive 10% of eligible compensation, each eligible employee must receive the contribution without regard to the employer’s profits for the year.
A money-purchase pension plan is suited for employers who are able to determine profit trends and do not mind being mandated to make contributions to the plan each year.
- 401 (k) or 401(k) Profit-Sharing Plan
An employer may choose to have a stand-alone 401(k) plan or a profit-sharing plan with a 401(k) feature. A 401(k) plan is a qualified plan that allows employees to defer receiving compensation in order to have the amount contributed to the plan. This arrangement is commonly referred to as cash or deferred arrangement (CODA). Contributions deferred by employees are referred to as elective deferrals, which are typically made to the 401(k) plan on a pre-tax basis.
The employer may also choose to make matching, non-elective or profit-sharing contributions to the plan. A 401(k) plan is suited for an employer who wants employees to assist with funding the plan.
- Employee Stock Ownership Plans (ESOPs)
Employee stock ownership plans (ESOPs) are a form of defined-contribution plan in which the investments are primarily in the employer’s stock. Congress authorized the creation of ESOPs as one method of encouraging employee participation in corporate ownership.
403 (b) Plans
A 403(b) plan is a retirement plan for certain public school employees, employees of tax-exempt organizations and ministers. Individual 403(b) accounts are established and maintained by eligible employees.
Individual accounts in a 403(b) plan can be any of the three following types:
- An annuity contract provided through an insurance company; these 403(b) annuity plans are also known as tax-sheltered annuities (TSAs) and tax-deferred annuities (TDAs).
- A custodial account provided through a retirement account custodian; investments are limited to regulated investment companies, such as mutual funds.
- A retirement income account, for which investments options are either annuities or mutual funds.
The employer may determine the financial institution(s) at which individual employees may maintain their 403(b) accounts, which in turn determines the type of 403(b) accounts that the employees may establish and fund. Our Advisors at SkyOak will help you choose the best plan or combination of plans.
The following are advantages of maintaining a 403(b) plan or account:
For the employer:
- Attractive benefits that help keep high-quality employees happy.
- A shared cost of funding between employers and employees (in some cases, only employees contribute to the 403(b) plan).
For the employee:
- Reduced taxable income through pre-tax contributions,
Tax-deferred earnings on plan contributions. If the contributions are made to a Roth 403(b) account, earnings can be tax-free.