Plan Types

401(k) Plans

More and more employees view 401(k) plans as a valuable benefit, which has made them the most popular type of retirement plan today. Employees can benefit from a 401(k) plan, even if the employer makes no contribution. Employees can voluntarily elect to make pre-tax contributions through payroll deductions up to an annual maximum limit. The plan may also permit employees age 50 and older to make additional “catch-up” contributions, up to an annual maximum limit. Employee contributions are 100% vested at all times.

The plan may also permit employees to make after-tax Roth contributions through payroll deductions instead of pre-tax contributions. Roth contributions allow an employee to receive a tax-free distribution of the contributions and the earnings on the employee’s Roth contributions if the distribution meets specific requirements.

The employer will often match some portion of the amount deferred by the employee in order to encourage greater employee participation (e.g., 25% match on the first 4% deferred by the employee). Since a 401(k) plan is a type of profit-sharing plan, profit sharing contributions may be made in addition to, or instead of, matching contributions. Many employers offer employees the opportunity to take hardship withdrawals or to borrow from the plan.

Employee and employer matching contributions are subject to special nondiscrimination tests, which limit how much the group of employees referred to as “highly compensated employees” can defer based on the amounts deferred by the “non-highly compensated employees.” In general, employees who fall into the following two categories are considered to be highly compensated employees:

  1. An employee who owns more than 5% of the business at any time during the current plan year or immediately preceding plan year (ownership attribution rules apply which treat an individual as owning stock owned by his or her spouse, children, grandchildren or parents); or
  2. An employee who received compensation in excess of the indexed limit in the preceding plan year. The employer may elect that this group is limited to the top 20% of employees based on compensation.

401(k) Safe Harbor Plans

401(k) plans require special nondiscrimination testing (ADP & ACP) which limit the deferrals of highly compensated employees to the average deferrals of the non-highly compensated employees. Quite often the passing of these tests will limit the deferrals of highly compensated employees; or will require additional contributions from the employer. The employer must provide a safe harbor notice to all employees on a timely basis. The safe harbor may be changed from plan year to plan year with appropriate notice to employees.

Qualified Retirement Plans

A qualified plan must meet a certain set of requirements outlined in the Internal Revenue Code such as minimum coverage, participation, vesting, and funding requirements. In return, the IRS provides tax advantages to encourage businesses to establish retirement plans, including:

Qualified plan assets are protected from creditors of the employer and employee. Employers can choose between two basic types of retirement plans: defined contribution and defined benefit. Both a defined contribution and a defined benefit plan may be structured to maximize benefits. Our consultants can help you choose the right plan for your company. Listed below is a description of the types of plans that are available.

Defined Contribution Plans

Under a defined contribution plan, the contribution that the company will make to the plan and how the contribution will be allocated among the eligible employees is defined. Individual account balances are maintained for each employee. The employee's account grows through employer contributions, investment earnings, and, in some cases, forfeitures (amounts from the non-vested accounts of terminated participants). Some plans may also permit employees to make contributions on a before- and/or after-tax basis.

Since the contributions, investment results, and forfeiture allocations vary year by year, the future retirement benefit cannot be predicted. The employee's retirement, death, or disability benefit is based upon the amount in his or her account at the time the distribution is payable. Employer account balances may be subject to a vesting schedule. Non-vested account balances forfeited by former employees can be used to reduce employer contributions or can be reallocated to active participants.

Money Purchase Plans

This plan is a type of defined contribution plan in which the employer's contributions are determined by a specific formula, usually as a percentage of pay. Contributions are not dependent on company profits.

Profit-Sharing Plans

The profit-sharing plan is generally the most flexible qualified plan that is available. Company contributions to a profit-sharing plan are usually made on a discretionary basis. Each year the employer decides the amount, if any, to be contributed to the plan.

The contribution is usually allocated to employees in proportion to compensation. It may be allocated using a formula that is integrated with Social Security, resulting in more substantial contributions for higher-paid employees.

Amounts contributed to the plan accumulate tax deferred and are distributed to participants at retirement, after a fixed number of years or upon the occurrence of a specific event such as disability, death, or termination of employment.

Age-Weighted Profit-Sharing Plans

Profit-sharing plans may also use an age-weighted allocation formula that takes into account each employee's age and compensation. This formula results in a significantly larger allocation of the contribution to eligible employees who are closer to retirement age. Age-weighted profit-sharing plans combine the flexibility of a profit-sharing plan with the ability of a pension plan to provide benefits in favor of older employees. The age-weighted plan allows the company to contribute up to 25% of eligible payroll each year. Unlike the typical profit-sharing plan, the total contribution to an age-weighted plan is allocated based on the employee's age. The older employees will receive a higher contribution than younger employees. This plan type is favorable when the employees targeted to receive larger allocations, are both older and more highly compensated than all other employees.

New Comparability Plans

New comparability plans, sometimes referred to as “cross-tested plans,” are usually profit-sharing plans that are tested for nondiscrimination as though they were defined benefit plans. By doing so, certain employees may receive much higher allocations than would be permitted by standard nondiscrimination testing. New comparability plans are generally utilized by small businesses that want to maximize contributions for owners and higher paid employees while minimizing contributions for all other eligible employees.

Employees are divided into groups based on valid business classifications, e.g., owners and non-owners. Each group may receive a different contribution percentage. For example, a higher contribution percentage may be given for the owner group than for the non-owner group, as long as the plan satisfies the nondiscrimination requirements.

Davis Bacon Plans

For Davis Bacon plans, this is directly from the DOL:

The Davis-Bacon and Related Acts apply to contractors and subcontractors performing on federally funded or assisted contracts in excess of $2,000 for the construction, alteration, or repair (including painting and decorating) of public buildings or public works. Davis-Bacon Act and Related Act contractors and subcontractors must pay their laborers and mechanics employed under the contract no less than the locally prevailing wages and fringe benefits for corresponding work on similar projects in the area.

The Davis-Bacon Act directs the Department of Labor to determine such locally prevailing wage rates. The Davis-Bacon Act applies to contractors and subcontractors performing work on federal or District of Columbia contracts. The Davis-Bacon Act prevailing wage provisions apply to the “Related Acts,” under which federal agencies assist construction projects through grants, loans, loan guarantees, and insurance.

Employee Stock Ownership Plans

Employee stock ownership plans (ESOPs) are ERISA-authorized, defined contribution plans that invest in Employer Stock. In addition to the normal IRS rules, ESOPs have many rules that only apply to them, requiring a knowledgeable Third-Party Administrator to ensure that all IRS requirements are satisfied.

ESOPs also have the ability to borrow money (a leveraged ESOP) to purchase Company Stock. This unique feature allows leveraged ESOPs to be used to transition ownership to the Employees as part of an overall ownership transition plan, as it can often be a preferred alternative to selling the Company to a third-party. Additionally, employee ownership offers a unique mix of benefits including independence, flexibility, and legacy preservation, and provides the employees a way to share in the success of the company.

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