Frequently Asked Questions
- How can I determine the best retirement plan for my company?
- We have an existing 401(k) plan that seems to be working fine; however, some of our management employees have been told that they have to reduce their pretax deferrals. Can anything be done to solve this problem?
- Many of my employees are unsophisticated investors and have told me that they are reluctant to contribute to a retirement plan where they have to make their own investment decisions. How can we make them comfortable enough to make the plan successful without spending a fortune on investment education and/or guidance?
- I’ve heard that some companies have adopted an automatic enrollment approach to increase participation by rank-and-file employees. How does this work, and what are the advantages and disadvantages of this kind of plan design?
- A safe harbor 401(k) plan design allows highly compensated employees (HCEs) to defer the maximum pretax dollar amount allowed by law without having to worry about the various IRS nondiscrimination tests. How does this work?
- Whatever happened to the old-fashioned pension plan where employees didn’t have to contribute any of their own money or worry about how they should invest for retirement?
- Under a defined benefit pension plan, how much may be contributed and deducted by the sponsoring employer? What is the maximum amount that an individual participant can receive each year and at retirement?
- Is there any way to provide retirement benefits to only certain employees without having to treat everyone the same? Are there any limits on what may be provided?
- Defining company goals, identifying budgetary restrictions, and comparing the benefits/costs of the various plan design options are critical first steps. Understanding the responsibilities to be assumed by in-house staff and outside service providers comes next. Finally, annual administration costs need to be identified and evaluated as to competitiveness and comprehensiveness.
- There are several potential solutions to this problem, ranging from trying to increase the level of participation by the plan’s lower-paid employees, to making QNEC contributions to pass the required nondiscrimination tests, all the way to adopting a safe-harbor design under which there are no testing restrictions applicable to highly-compensated employees (HCEs). The cost implications of each approach can vary significantly; an analysis of the alternatives should be conducted before a decision is made as to the best course of action.
- You need to help them understand that they don’t have to be investment experts to make good, sound long-term investment decisions. There are numerous tools available that are easy to understand and cost little to nothing to communicate. This communication is essential and is something in which Boulay Donnelly & Supovitz has specialized for nearly 30 years.
- Automatic enrollment is a plan design technique that has been used successfully to increase plan participation by taking advantage of the fact that most people will follow the "path of least resistance" when faced with a relatively benign decision. Under this approach, new employees are automatically enrolled in the 401(k) plan upon eligibility unless they specifically “opt out” of the election to defer; the most common automatic deferral percent is 3 percent. With automatic enrollment, employers send the message to new employees that they expect/want them to participate in the plan. Statistics show that nearly 70 percent of the employees automatically enrolled do not make the effort to opt out of the 3-percent pretax payroll deduction.
There are two potential disadvantages to automatic enrollment. The first is where a company has relatively high employee turnover, thereby resulting in the maintenance of a large number of smaller employee accounts, which may increase the plan’s administrative expenses and/or the time spent internally processing distributions. The second issue involves the investment of the automatic enrollees' contributions, although use of an automatic investment default option can address this issue quite effectively.
- In essence, the IRS allows plan sponsors to “buy” passage of the nondiscrimination tests (ADP and/or ACP test) by guaranteeing to make an annual contribution to the plan on behalf of all employees (or, if desired, all NHCEs) on one of two bases—a flat, 3 percent of pay contribution for all eligible employees (even those not making any of their own pretax 401(k) deferrals), or a matching contribution equal to 100 percent of the first 3 percent of a participant’s 401(k) deferrals plus 50 percent of the next 2 percent of such deferrals. The first option is payable to the accounts of all eligible employees, thereby “costing” the employer 3 percent of all eligible employees’ annual pay. The matching contribution option may cost more or less than the 3 percent of payroll cost of the first option, depending on the level of participation by those eligible. For employees not deferring any of their own money, the matching contribution cost is zero; for employees deferring 5 percent or more of their pay, the matching contribution cost is 4 percent of annual pay.
- While there’s no doubt that 401(k) and other defined contribution plans have become the most common types of retirement plan, the traditional defined benefit pension plan continues to be the most appropriate plan design in a number of situations. From larger companies with and without collectively bargained benefits, to small firms and sole proprietorships, defined benefit pension plans remain the only way to guarantee a predetermined level of retirement benefits for all participants. This type of plan may also allow smaller employers the opportunity to fund retirement benefits with tax-deductible contributions far in excess of the limits applicable to 401(k) and/or profit-sharing plans.
- The sponsor of a defined benefit pension plan may contribute and deduct whatever amount is determined to be necessary to properly fund the promised (defined) benefits. This amount must be determined by an enrolled actuary and may vary from year to year depending upon the plan’s benefit formula, changes in participants’ compensation, the plan’s investment experience, and so on. There is no maximum dollar or percentage of pay limitation on the amount of the annual deductible contribution; rather, the IRS limits the amount of benefit that may be provided at retirement.
Unlike 401(k) or other defined contribution plans where an individual account is maintained for each participant, defined benefit pension plans are “unallocated” funding vehicles; that is, plan assets are invested collectively for all participants, with no separate accounting maintained by individual. Consequently, there is no statutory limitation on the annual dollar amount that may be contributed on an individual’s behalf, only the amount of the benefit to be provided is subject to limitation. For this reason, it is possible for a plan sponsor to make annual deductible contributions to a defined benefit pension plan far in excess of what would be allowable under any type of defined contribution plan.
- The IRS allows employers to provide benefits for selected individuals only under what is commonly known as a supplemental executive retirement plan (SERP). SERPs are generally established for a select group of more highly compensated employees and are not subject to the coverage, participation, or nondiscrimination rules of ERISA. Contributions to such plans are not subject to the contribution/deduction limits of IRS-qualified plans, nor are there any limitations on the amount of SERP benefits that may be provided. Benefits may also vary by participant, thereby allowing plan sponsors to tailor the SERP provisions to meet the individual needs/objectives of each participant. The tax treatment of SERP contributions and distributions differs from that applicable to IRS-qualified plans. Concepts such as “constructive receipt” and “substantial risk of forfeiture” play a large role in the design of all SERPs; while plan funding is also handled much differently in order to optimize the tax efficiency of the benefits provided.