Plan Types

Qualified Plans

The IRS has created a number of retirement savings vehicles for employers of all sizes to use to save for their and their employees’ retirement.

A qualified plan must meet a number of Internal Revenue Code requirements under Section 401(a) such as minimum coverage, benefits, participation, and vesting to name a few.

In return, the IRS provides the following tax advantages when businesses set up plans:

  • Deductions for current contributions
  • Tax deferred earnings on investments until distribution
  • Employees may have opportunity to make pre tax or after-tax contribution
  • Deduction for ongoing plan expenses
Man looking over Qualified Plans: IRS retirement savings vehicles

In addition to tax benefits, qualified retirement plans have the following advantages:

  • Attract talented employees with a great benefit package
  • Retain valued employees by rewarding their service
  • Disciplined savings tool to help employees meet retirement needs
  • Significant savings accumulation in a short period of time
  • Protection from creditors

Qualified plans fall into two basic types of retirement plans: DC (Defined Contribution) and DB (Defined Benefit) plans.

Below is a brief overview of some of the plan designs that our consultants will customize to best fit for your needs.


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Plan Types

Defined Contribution Plans

Defined Contribution Plans operate, per their name, with a “defined contribution” or determinable amount allocated to eligible employees.

These contributions along with any earnings are maintained in an account (either pooled or segregated) for each employee’s benefit. Contributions to the plan may consist of pre-tax employer and/or pre-tax and/or post-tax employee contributions.

The ultimate retirement benefit or benefit upon distribution of each participant will be dependent on the contributions and earnings experienced by the account, with investment control either by the employer or by the employee. For this reason, the future retirement benefit cannot be determined or guaranteed.

Employer contributions may be subject to a vesting schedule. Non-vested account balances forfeited by former employees can be used to reduce employer contributions or be reallocated to active participants.

Man pointing at employee retirement savings

For 2020 and 2021, an employee’s contributions to the plan may not exceed $19,500 (or $26,000 for employees age 50 or over). 

The employer contribution, when combined with the employee contribution may not exceed the lesser of $57,000 for 2020 and $58,000 for 2021 or 100% of an employee’s compensation. The company may make a deductible plan contribution up to 25% of the overall eligible payroll. 

The maximum eligible compensation that can be considered for any single employee is $285,000 in 2020 and $290,000 in 2021.

Defined Contribution Plan Types

The 401(k) feature allows employees to voluntarily elect to make contributions (deferrals) into a qualified plan through payroll deductions up to an annual $19,500 limit for 2020 ($26,000 if age 50 of over). The term 401(k) comes from Section 401(k) of the Internal Revenue Code relating to employee deferral of compensation.

It may be helpful to think of qualified retirement plans as having multiple potential buckets or sources of funding (i.e. profit sharing, deferrals, matching).

Traditional Pre-Tax Deferrals

Employee contributions to the plan will be made on pre-tax basis, and subsequently reduce the reportable income on an employee’s W-2. Their account will grow tax deferred until the time the funds are withdrawn and reported as income.

ROTH Post-Tax Deferrals

If elected as a plan option, employees may elect to have their voluntary deferral be made to the plan on a post-tax basis. These contributions will grow tax free and be able to be withdrawn upon retirement with no further tax consequences. Roth is offer preferred if you believe you will be in a higher marginal tax rate during retirement.

Matching Contributions

Employers may choose to match some portion of the amount deferred by the employee to encourage greater employee participation, i.e., 50% match on the first 6% deferred by an employee. These employer contributions may be subject to a vesting schedule

Employee deferrals and employer matching contributions are subject to annual nondiscrimination tests which limit how much “Highly Compensated Employees” can defer or benefit based on the “Non-Highly Compensated Employees” contributions. A “Highly Compensated Employee” is an employee that:

  • Owns more than 5% of the employer at any time during the current or prior plan year (attribution rules apply which treat an individual as owning stock owned by his spouse, children, grandchildren or parents); or
  • Received compensation in excess of the indexed limit in the preceding plan year (indexed limit is $120,000 for 2018 and $125,000 for 2019).

401(k) Safe Harbor Plans

An option exists to offer certain “401(k) Safe Harbor” plan designs which are deemed to pass the discrimination testing mentioned above. By promising certain employer profit sharing or matching contributions that are 100% vested, Highly Compensated Employees can defer up to the annual limit regardless of participation of other employees.

These plans are similar to a 401(k) but are only available to be offered by non-profit employers. These plans can either be ERISA or Non-ERISA depending on the level of employer involvement in selecting the investment provider of if any employer contributions are made to the plan. 

At the current time, the main difference relates to how the assets are held, eligibility requirements, discrimination testing of employee deferrals, and a special allowable catchup contribution.

Profit Sharing plans consist of employer contributions that are generally made on a discretionary basis. After the end year, with our guidance, the employer will decide on an amount, if any, to be contributed to the plan. Any contributions will be tested to be non-discriminatory. These plans can stand on their own or be a money type under a 401(k) or an ERISA 403(b) plan.

We surprisingly still find many plans using an inflexible Pro Rata allocation (where  contributions are allocated in proportion to each employee’s compensation) or an Integrated allocation (where contribution are allocated taking into account Social Security, resulting in a larger percent contributions to employees with salary above the taxable wage base).

Almost all of our plan use a flexible New Comparability allocation. Allocations of varying percentages can be allocated to different groups of employees. Sometimes referred to as “Cross Tested” plans, these plans are tested for compliance on a benefits basis, like a DB plan. Small businesses wanting to direct a larger amount of contributions to older owners and key employees, while having ultimate control over contributions to the rest of the employees find this method powerful. 

Higher allocations can be given to select employees, as long as we can prove mathematically that the allocation is non-discriminatory when compared the benefits provided at retirement age.

Companies with non-union employees working on public projects required to pay a prevailing wage may contribute the portion allowable for fringe benefits to a qualifying retirement plan. If not using the fringe portion for benefits, amounts must be included in payroll as compensation. 

The benefits to an employer of implementing a prevailing wage plan are as follows:

  • Savings in payroll taxes (FICA, Medicare, Federal and State unemployment)
  • Lower workers’ compensation premiums
  • Contributions can potentially be used to offset other employer contributions
  • Ability to make more competitive bids to help win more prevailing wage work
  • Can be combined to be a money type under 401(k) plan instead of a separate plan

A Multiple Employer Plan, or “MEP”, is a retirement plan (either defined contribution or defined benefit) that is maintained by two more unrelated employers that are not members of the same controlled group.

Businesses will elect to be an “adopting employer” of the plan. DOL rulings indicate that a MEP must cover a bona fide group of employers to constitute a single plan, currently otherwise separate 5500 filings would be required.

A single document and investment solution are used for all employers under the plan.

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Plan Types

Defined Benefit Plans

Defined Benefit Plans operate, per their name, with a “defined benefit” provided to employees at retirement. 

On an annual basis, an actuary determines a minimum required, maximum allowed, and recommended contribution for the employer based on the current plan assets when compared to the current plan liabilities to meet projected retirement benefits. The responsibility for funding the individual liabilities lies with the employer who invests all of the overall plan assets. Investment gains/losses will not affect participants’ benefits, but may require smaller or larger contributions by the employer.

Defined Benefit Plans are often appealing to employers who are looking to contribute more than that $57,000 maximum defined contribution limit. 

In a DB Plan, the maximum benefit that can be funded for is the lesser of $230,000/yr at retirement or 100% of highest 3 year average compensation. 

Substantial deductible contributions are allowed to be made to the plan in order to create a large enough funding source to fund the accrued benefits.

Woman reviewing options of Defined Benefit plan

A Cash Balance Plan is a type of Defined Benefit Plan that will appear more like a Defined Contribution Plan to participants, but operate like a Defined Benefit Plan for funding purposes. 

For this reason, these plans are referred to as hybrid plans. Participants will receive a Cash Balance statement with a hypothetical balance and earnings, instead of a traditional Defined Benefit statement expressed as a fixed monthly benefit upon retirement.

In a Cash Balance Plan, each employee’s “account” receives an annual contribution credit and an interest credit based on a guaranteed rate as stated in the plan document. An employee’s plan benefit is equal to the hypothetical account balance which represents the sum of all contributions and interest credits. For employees, they can more easily understand their plan benefit and count on a determinable amount that is not affected by market fluctuations for financial planning purposes.

As in a traditional defined benefit plan, the employer in a cash balance plan bears the investment risks and rewards. An actuary will determine the minimum required, maximum allowed, and recommend contribution to keep the plan funded on a termination basis. 

Though unlike a traditional DB Plan, the liabilities in a Cash Balance plan are more predictable, since benefits are credited on a year by year basis in relation to the current year and will grow at the plans stated interest rates.

Instead of an individual account balance based on contributions and earnings, a defined benefit plan promises a monthly benefit at retirement funded by a pooled trust.

The benefit formula is stated in the plan document and is generally based on a participant’s average compensation and years of service.

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