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How to Choose the Right Retirement Plan for You or Your Clients

Sept. 23, 2022, 8:45 AM

When choosing a retirement plan, you must carefully consider the goals involved. They could be any combination of tax deductions and tax-deferred growth, retirement fund accumulation, asset protection, employee attraction and retention, or perhaps some other deduction.

There are two types of retirement plan categories: defined benefit pension plans and defined contribution plans. Prior to DC plans, the primary vehicle for retirement savings was the DB plan. Employers would fund a pension, and employees would benefit from a guaranteed income stream in retirement. Fast forward a few decades after the introduction of the 401(k) plan, and you’ll be hard-pressed to find an employer that offers a DB plan. The reason is simple: cost. The guaranteed aspect of a DB plan is burdensome and, in some instances, detrimental to the health and longevity of the sponsoring employer.

So how does one decide which plan is the right one? Start by asking a fundamental question: What are you trying to accomplish? There are several reasons to implement a retirement plan: tax-deductions and salary deferral; accumulation of retirement assets; attraction and retention of employees; your business is a high-risk profession, and you want to protect what you’ve earned through a non-pierceable trust; and participant education and guidance. These are not the only reasons, but they tend to rise to the top of the list.

As a corporate retirement plan adviser, I urge people to do two things. First, meet with a fiduciary adviser specializing in the retirement plan space, placing the clients’ best interest at the forefront. Second, consult with your tax adviser, the individual who knows more about your financial situation than perhaps anyone else—other than yourself, of course.

These steps can help you determine which retirement plan option is the right one, based on current facts and circumstances.

401(k) Profit-Sharing Plan

401(k) and profit-sharing plans can be separate. But by combining the two, you create plan administration and fee efficiency. The 401(k) accommodates participant salary deferrals either pre-tax or as Roth contributions. The maximum participant salary deferral in 2022 is $20,500. And if the person is 50 or older, they can defer up to an additional $6,500 of salary as a catch-up contribution. Employers can provide a discretionary matching or non-elective contribution (e.g., profit sharing). Total contributions from all sources (e.g., salary deferral, match, and profit sharing) cannot exceed $61,000 for the 2022 plan year.

This is a basic 401(k) profit-sharing plan. Through plan design, you can include significant enhancements such as safe-harbor contributions, advanced profit-sharing options, automatic enrollment, and escalation with an opt-out feature. The 401(k) profit-sharing plan offers the most flexibility and largest salary-deferral opportunity for all participants and weighted company contributions for targeted participants.

Cash Balance

The cash balance plan is essentially a DB plan, with a few differences that can make it more palatable for business owners. It’s often used by companies composed of owners or smaller groups with considerable cash flow interested in maximizing retirement savings for select individuals—typically the owners. It also provides a meaningful benefit to the employee base. It can be a standalone plan or combined with a 401(k) profit sharing plan, which maximizes the tax-deduction and contribution benefit. Annual contributions for business owners can be as high as a few hundred thousand dollars.

But with a DB plan, the plan sponsor is obligated to make annual contributions. Additionally, through plan design, you can create a cost-benefit scenario that maximizes the benefit for key employees (e.g., owners, executives) while minimizing the total contribution expense to the remaining eligible employees.

Owner-Only 401(k) Plan

Here, only owners and spouses of owners can participate. It provides for discretionary salary deferral and profit-sharing contributions. It can be coupled with a cash balance plan, yielding additional tax benefits and retirement savings.

Simplified Employee Pension (SEP)

Often used by small businesses or self-employed individuals, SEPs allow for employee contributions only, not to exceed 25% of earned income. In the year that contributions are made, they must be provided to all eligible employees. The owner contributes to a SEP IRA, and participants invest the money. They are very easy to manage and devoid of employer filing requirements. However, professional advisory education or guidance is not typically provided to the participants.

Savings Incentive Match Plan for Employees (SIMPLE)

SIMPLE 401(k): This is a cross between the SIMPLE IRA and the traditional 401(k) plan. It’s available to employers with fewer than 100 employees and is far less complicated to administer and manage. The maximum participant salary deferral in 2022 cannot exceed $14,000, and the catch-up contribution maximum is $3,000. Additionally, employer contributions are mandatory. It can be a match of 100% on the first 3% a participant elects to defer or a non-elective contribution of 2% of the eligible employee contribution. This is a “simplified version” of a traditional 401(k) plan.

SIMPLE IRA: This is similar to a SIMPLE 401(k) with a pair of key differences. First, an employer electing to make matching contributions can reduce the amount to less than 3% but not less than 1% two out of every five years. This is not permissible in a SIMPLE 401(k). Second, loans are not permissible in a SIMPLE IRA. They are permissible, however, in SIMPLE 401(k) and a traditional 401(k) plan.

403(b) Plan

This allows for salary deferral and employer contribution to those employed within government agencies, educational institutions, and nonprofit organizations. It is not subject to the Employee Retirement Income Security Act of 1974 unless there is “involvement on behalf of the employer,” such as an employer providing a contribution to eligible participants.

Individual Retirement Account (IRA)

This is a non-business-related retirement account, which means that individuals with earned income can open an IRA account and save toward retirement. One should maximize their employer-sponsored benefits first and then consider funding an IRA. This option can be established as a traditional IRA or a Roth IRA.

Conclusion

Due to the many choices available, along with the levels of complexity for each, it is highly recommended that you consult with a corporate retirement plan specialist willing to sign on as a plan fiduciary and your tax adviser to determine which plan is best.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Michael A. Abate, AIF, CRPS, leads the corporate retirement plan practice at EisnerAmper Wealth Management & Corporate Benefits, LLC.

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