Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Initial steps:
• Gather relevant facts
• Identify employer goals and objectives
• Select plan features that meet objectives
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Advantages for the employer:
• Help employees with retirement savings
• Tax deferral for owners and highly compensated
employees
• Help recruit, reward, retain, and retire employees
• Encourage productivity
• Discourage collective bargaining
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
• Employers may use qualified or nonqualified plans
to meet their planning objectives
• Qualified plans – enjoy tax advantages but must
meet strict IRS rules to ‘qualify’ for those advantages
• Nonqualified plans – allow employers more flexibility
in plan design, but offer far fewer tax advantages
than qualified plans
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
A nonqualified plan allows an employer to provide
benefits for key employees that …
• do not have to be duplicated among rank and file
employees
• can exceed the dollar limits imposed under qualified
plans
• can be custom tailored to meet needs of select
executives or key employees
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
With a nonqualified plan, an employer can:
• Recruit a key employee when matching or exceeding
benefits of their current employer would make offered
benefits exceed benefit levels given other employees
• Reward the individual or group that makes a
substantial contribution to the success of the business
• Enable a business owner to use company earnings in
ways that reduce or defer taxes and accumulate
wealth
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Tax Advantages of Qualified Plans
• Plan contributions (employer contributions and
employee salary reduction contributions)
- tax deductible for employer
- tax deferred for employee
• Earnings on plan investments accumulate tax deferred
• Some lump sum distributions may qualify for 10 year
averaging
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Types of Qualified Plans
Defined Contribution
- contribution to plan by employer or employee is specified,
but value of plan at retirement is not
- employee bears investment risk
Defined Benefit
- benefit to be paid to employee at retirement is specified
- employer responsible for meeting investment goals
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Defined Contribution Plans
Two Broad Types
• Money Purchase Pension Plan
– Employer must contribute stated percentage of employee
compensation to account each year (up to 25%)
• Profit Sharing Plan
– Employer determines amount of contribution, often based on
company profit
– Contributions must be made on nondiscriminatory basis,
often based on compensation
– Allocation can be weighted to favor older workers
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Defined Benefit Plans
• Plans funded on actuarial basis
• Funding amount greater for older employees
– Makes defined benefit plans attractive to
professionals or closely held business owners
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
In recent years, due to factors such as rising
cost of providing benefits and more frequent
job change among employees, the number of
Defined Benefit plans has declined while the
number of Defined Contribution plans has
grown
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Not all employees value retirement benefits:
• Younger employees
• Transient employees
• Low-paid employees
Plan design must
• Maximize benefits for those who want them
• Be perceived as providing valued benefits
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Which plan should an employer select?
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Which plan should an employer select?
A plan that matches, as best as possible,
employer goals and qualified plan
characteristics
Consider how employers might achieve the
following objectives
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Designing the Right
Retirement Plan
1.
Chapter 1
Employee Benefit & Retirement Planning
Employer wants to maximize the portion
of plan costs that benefit highlycompensated employees.
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Designing the Right
Retirement Plan
1.
Chapter 1
Employee Benefit & Retirement Planning
Maximize the portion of plan costs that benefit
highly-compensated employees.
- Defined benefit plans
- Service based contribution or benefit formulas
- Age weighting and cross-testing
- Combine defined benefit and defined contribution
plans
- 401(k) plans
- Social Security integration
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Designing the Right
Retirement Plan
2.
Chapter 1
Employee Benefit & Retirement Planning
Provide a savings medium that
employees perceive as valuable
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Designing the Right
Retirement Plan
2.
Chapter 1
Employee Benefit & Retirement Planning
Provide a savings medium that
employees perceive as valuable
- Defined contribution plans
- Cash balance plans
- Plans with employee participation
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Designing the Right
Retirement Plan
3.
Chapter 1
Employee Benefit & Retirement Planning
Provide adequate replacement income for
each employee’s retirement
- Defined benefit plan
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
4.
Create an incentive for employees to maximize
performance
-
Profit sharing plan
-
ESOP/stock bonus plan
-
Any other defined contribution or cash balance
plan
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
5.
Minimize turnover
-
Defined benefit plan
-
Graduated vesting
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Designing the Right
Retirement Plan
6.
Chapter 1
Employee Benefit & Retirement Planning
Encourage retirement
- Defined benefit plan
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
7.
Maximize employer contribution flexibility
-
Qualified profit sharing plans
-
SEPs
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Application Exercise
Software Solutions, Inc. is a 5 year old company that develops
computer programs for clients. Jeff, the owner, is 35; average age
of the 20 employees is 31. Jeff wants a plan that will encourage his
employees to be more productive, but will also help reduce
turnover. He’s also concerned about the cash flow of his young
company. Which plan (s) should Jeff consider?
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Designing the Right
Retirement Plan
Chapter 1
Employee Benefit & Retirement Planning
Application Exercise
• profit share or ESOP
-would encourage employees to produce more since
these plans are typically based on company profit
-would give Jeff discretion in contributions
•gradual vesting
-Could help reduce employee turnover
-Funds forfeited by non-vested, departing employees
could be used to benefit remaining employees
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