Retirement Plans

Plan Limits

Safe Harbor 401(k) Profit Sharing Plans

A 401(k) profit sharing plan may also have a safe harbor feature. This plan provision requires the employer to contribute a minimum of three percent of compensation to all employees or to provide a 100 percent match of the first three percent of compensation plus 50 percent of the next two percent of compensation for employees who defer. Both types of safe harbor contributions are immediately 100 percent vested.

401(k) Profit Sharing Plans

Some profit sharing plans have a 401(k) feature that allows eligible participants to defer a portion of their compensation into a retirement account. The money is contributed to the 401(k) plan on behalf of the participant instead of being paid as taxable compensation. In addition to the employee elective deferrals (also called salary deferrals), the employer may make profit sharing contributions to the plan according to the formula specified. The employer may also choose to make a matching contribution to the plan to reward employees who are deferring income to the 401(k) portion of the plan.

New Comparability (Cross-Tested) Profit Sharing Plans

Employer contributions are allocated by percentage to nondiscriminatory classification groups stated in the plan (e.g. owners, all other employees.) Each classification group receives a percentage of the employer contribution, usually with one classification group receiving a higher percentage than the other classification groups. The plan must pass nondiscrimination testing to ensure that non-highly paid employees are receiving an equitable contribution in comparison to the highly paid employees. (Example below.)

Traditional Profit Sharing Plans

The employer contributes a discretionary percentage of each participant's annual salary to the plan, to a plan maximum of 100% of compensation. In a profit sharing plan, the contribution level is selected by the plan trustee(s) each year. Annual contributions are not required, provided that contributions are made on a substantial and recurring basis, as defined by the Internal Revenue Service.

Money Purchase Pension Plans

The employer contributes a specified fixed percentage of each participant's annual salary to the plan each year, to a maximum of 25% of compensation. Contributions to a Money Purchase Pension Plan are not based on employer profits, therefore contributions must be made regardless of whether the company is profitable. With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), money purchase plans have become obsolete and many are being converted to profit sharing plans.

Defined Contribution Plans

There are several variations of defined contribution plans. A few of the more common ones include:

Defined Benefit Plans

A defined benefit plan provides a predetermined, level of benefit payments for the life of the participant or the life of the participant and spouse. The monthly retirement benefit is calculated using a formula specified in the plan. The employer contribution is required annually and is typically higher than a defined contribution plan, depending on the employer's demographics. The employer bears the investment risk. Older employees tend to be favored because they have a shorter time to fund for their retirement.

Types of Defined Benefit Plans:

Traditional Defined Benefit Plan

The employer makes an annual tax-deductible contribution to the plan. Tax deductions are subject to Internal Revenue Code limitations. This amount is actuarially determined each year and is usually a formula based on a combination of compensation and years of service. The plan is funded entirely by the employer and annual contributions are required.

Cash Balance Plan

A cash balance plan is a type of defined plan that has the characteristics of a defined contribution plan. Each year a participant's account is credited with a pay credit card and an interest card. The pay credit is dependent upon each participant's compensation. The Growth of the participant's accounts depends on the pay credits that the employer contributes. A cash balance offers more profitability than traditional pension plans since participants can take his/her vested account as a lump sum upon termination of employment.

Syndicate content
401(k) PLANS/403(b) PLANS
The calendar year limitation on elective deferrals underIRC §402(g)(1).