Advisors

A traditional 401(k) plan allows eligible employees the ability to defer a portion of their wages pre-tax through payroll deductions. In addition, employers have the option of making matching contributions based on employees’ deferrals.  The deferrals and matching contributions of Highly Compensated Employees may be limited by required non-discrimination testing.

A profit sharing component can also be added to this plan design.

Similar to a traditional 401(k) plan, this design incorporates a “safe-harbor” component.  The employer must make a safe-harbor contribution consisting of either: 1) a minimum 3% contribution to all eligible employees or 2) a matching contribution to those deferring of at least 100% of the first 3% deferred plus 50% of the next 2% deferred.  The safe-harbor contributions are always 100% vested.

A profit sharing component can also be added to this plan design.

The Roth 401(k) simply adds a second type of deferral that is an after-tax contribution.  There is no immediate tax-deduction. However, the benefit of the Roth feature is that all assets including the gains grow tax free.  That means assets are withdrawn tax-fee at retirement (including the earnings).  A traditional pre-tax deferral component must always be offered as well.

A profit sharing component can also be added to this plan design.

A profit sharing plan is differentiated from other plans such as an SEP based on the formula written into the document.  The various formulas include:

Traditional Formula – this formula normally allocates a desired employer contribution among the eligible employees on a pro-rata basis in relation to their compensation.

Integrated Formula – this formula allows the Federal Social Security benefits to be incorporated into the allocation thereby skewing more of the employer contribution to those employees with compensation exceeding the Social Security Taxable Wage base.

New Comparability Formula – this formula allows the employer contribution to be allocated in different percentages to various groups. Normally, the goal is to provide greater benefits to key employees and/or the business owner(s).  This formula requires non-discrimination testing that can influence the allocation to various groups.

Due to increased deduction limits to the profit sharing plan, the money purchase plan has become less popular.  One drawback of this plan type is that the employer contribution is based on a fixed formula written into the plan document providing no flexibility from year-to-year without a formal plan amendment.

An MEP is sponsored by a single employer with one or more unrelated (not under common ownership) employers becoming “adopting employers”.  The concept is to allow unrelated companies to participant in a single plan thereby sharing in the annual plan management costs.

The defined benefit plan allows for larger contributions when compared to the defined contribution plans.  However, the DB plan is more complex and requires a yearly actuarial valuation.  The employer guarantees the plan benefits and bears the investment risks.

A now popular type of defined benefit plan is a “Cash Balance Plan”.  The cash balance plan is a “hybrid” defined benefit plan that has some features resembling a defined contribution plan.  Each participant has a hypothetical account that grows in two ways… First the account is credited with an interest crediting rate and second, the account receives an employer contribution based on the plan’s formula.  Contrary to a 401(k) plan, the cash balance benefits are guaranteed to the participant and the employer bears the investment risks.

Operating a 401(k) Profit Sharing in tandem with a Defined Benefit/Cash Balance plan can allow for lower costs to participants relative to the significant benefits to desired groups such as key employees and/or business owner(s). These designs require combined plan non-discrimination testing and therefore, are more complex to administer requiring a highly skilled team to manage the plans from year-to-year.