401(k) Retirement Plans
A company 401(k) plan for your employees is one of the most popular and common of company-sponsored retirement plans available today. They can be a great way to encourage your employees to save for their retirement as they allow your team members to put money aside in a tax-deferred plan.
A 401(k) is a provision added to a profit sharing plan, however profit sharing may be discretionary.
- Employer contributions are deductible on the employer’s federal tax return to the extent that the contributions do not exceed the limitations described in section 404 of the Internal Revenue Code.
- Elective Deferrals and investment gains are not currently taxed and enjoy tax deferral until distribution.
- The administrative costs of running the plan that are paid by the Plan Sponsor are tax deductible.
Several things can make 401(k) Plans very attractive to your employees:
- In a traditional 401(k) plan, the money that employees defer from their paychecks is pre-tax, which means an employee contributes a portion of his wages before taxes are taken out. The employee’s taxable income then drops by the amount he contributed.
- If a Roth feature is added to the 401(k), it allows employees to designate some or all of their deferrals as “ROTH elective deferrals” that are generally subject to taxation under the rules applicable to ROTH IRA’s. Roth deferrals are included in the employee’s taxable income in the year of deferral.
- As an additional benefit, a 401(k) may offer an employer match in which the employer matches employee’s deferrals, up to a certain percentage. It’s basically “free money” to an employee.
- Some employers may also offer a profit-sharing contribution to their 401(k) plans.
Restrictions regarding early withdrawals401(k) Plans do come with some strong restrictions regarding early withdrawals:
- An employee cannot access any of his contributions or his employer’s until he reaches age 59 ½ (although he can if he leaves your employ when he’s 55 or older) without penalty
- The early withdrawal penalty is 10 percent of the withdrawal total. The employee also will have to pay taxes on the money he withdraws (because it has become income).
Employees who leave your companyThose employees may take their contributions and vested employer contributions in one of three ways. They can:
- They may elect to keep it in your plan, letting it grow until they retire. (Some exceptions may apply).
- Withdraw the money from your plan (and take on applicable penalties), or
- Roll it over without penalty into an Individual Retirement Account (IRA) or another employer’s qualified plan.
WHO is an Ideal Plan Sponsor?
- Goal: Plan Sponsors looking to attract and retain employees, as well as defer income for their own retirement.
- Demographic: Companies of any size. Eligible employees, regardless of age, can contribute to a 401(k) plan up to 100% of their annual compensation or the annual limit.
- Generosity: Although 401(k) plans do not require any employer contributions, they are still subject to non-discrimination testing. If a plan fails non-discrimination testing due to low employee engagement, two options may be available to resolve the issue:
- A Qualified Nonelective Employer Contribution (QNEC) can be made to non-highly compensated employees.
- A Corrective Distribution of excess contributions can be made to highly compensated employees.
WHY work with a Third Party Administrator (TPA)
- Consultative plan design can ensure that your plan conforms with your businesses’ retirement plan objectives.
- A TPA can assist in monitoring your plan’s evolution; as your business grows, so too will your plan needs.
- TPAs help ensure your annual plan data and participant records are accurate, and assist in keeping your plan compliant with IRS and DOL requirements.
What is a Profit Sharing Plan?
A “Profit Sharing” plan is a defined contribution plan in which employers have the discretion to determine when and how much the company pays into the plan. The contribution does not necessarily need to be linked to business profitability and may be as little as zero in a given year. The method by which employer contributions are made can vary based on plan design.
Did you know that all 401(k) plans are actually profit sharing plans? That’s right, a 401(k) provision simply allows for deferrals into a profit-sharing plan.
The amount allocated to each individual account is usually based on the salary level of the participant.
Profit sharing plans can be a compelling tool in encouraging financial security in retirement. These plans are a valuable option for businesses that are considering a retirement plan, providing benefits to employers and their employees.
Why starting a profit sharing plan?
A profit-sharing plan allows the employer to choose how much to contribute to the plan each year, including making no contribution for a year. It is a type of plan that gives employers flexibility in choosing the key features. Employers start a profit sharing plan for additional reasons:
- A well-designed profit sharing plan can help attract and keep employees.
- The money contributed to a profit sharing plan may grow through investments in savings accounts, stocks, mutual funds, bonds, money market funds, and other types of investments.
- Contributions and profits generally are not taxed by the Federal Government or by most state governments until they are apportioned.
- A profit-sharing plan may allow employees to take their benefits with them when they leave the company, easing administrative duty.
Many of the actions needed to operate a profit sharing plan involve fiduciary choices. This is true whether someone has been hired to manage the plan or do some or all of the plan management. Using discretion in hiring someone to administer and manage the plan makes them a plan fiduciary to the extent of that discretion or control. Hiring someone to perform fiduciary functions is itself a fiduciary act. Thus, fiduciary status is based on the functions performed for the plan, not a title.
Decisions to establish a plan
Some decisions with respect to a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan, and to terminate a plan are business decisions. When making these decisions, one is acting on behalf of their business, not the plan, and therefore, would not be a fiduciary. However, when steps are taken to implement these decisions, these administrators are acting on behalf of the plan and thus, in making decisions, and maybe acting as fiduciaries.
Therefore, the persons or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary’s responsibilities may include acting solely in the interest of the participants and their beneficiaries or acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries and defraying reasonable expenses of the plan. Additionally, they may be responsible for carrying out duties with the care, skill, discretion, and conscientiousness of a prudent person familiar with such matters. Having a prudent plan administrator who will following the plan documents, diversify plan investments is hugely important.
The responsibility to be prudent covers a wide range of functions needed to operate a plan. Since all these functions must be carried out in the same manner as a prudent administrator would, it is imperative that one consults various experts in many fields, such as investments and accounting.
The plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are collected. If the plan and other documents are silent or indeterminate, the trustee generally has this responsibility. As part of following the plan documents in operating the plan, the plan document will need to be updated from time to time for changes in the law.
Who is a Plan Sponsor?
- Goal: Businesses looking for flexible ways to allocate employer contributions in order to increase retirement readiness and achieve tax benefits.
- Demographic: Companies of any size can take advantage of this structure.
- Generosity: Contributions to eligible employees can vary based upon the profit sharing structure and employee demographic. Profit sharing plans are subject to age-based discrimination testing and include design options such as the following:
- Traditional: A pro-rata percentage of annual income or fixed dollar amount.
- Integrated: Also known as Permitted Disparity, this method accounts for Social Security compensation limits.
- Age Weighted: A greater percentage of profit sharing contributions are allocated to older employees.
- New Comparability: Creates categories of employees that can have differing allocations.
Let us provide you with assistance and our insight on how to appropriately set up, manage and update plan information. Contact Us today!