Types of Plans
- 401(k)/Profit Sharing
- Profit Sharing
- Money Purchase
- 403(b) ERISA and Non-ERISA
- Traditional Defined Benefit
- Cash Balance
- Combined Defined Benefit and 401(k)/Profit Sharing
A 401(k) provision is a feature of a tax-qualified Profit Sharing Plan that allows employees to contribute a pre-tax portion of their wages to individual accounts.
A Profit Sharing Plan is a type of Defined Contribution plan that lets companies help employees save for retirement. With a Profit Sharing Plan, employer contributions are generally discretionary. That means the company can decide from year to year how much to contribute (or whether to contribute at all) to the plan. If the company does not have a profit, it does not have to make contributions to the plan. (But a company does not need to be profitable to have a Profit Sharing Plan.) There are several types of Profit Sharing formulas that can be utilized to allocate the contribution among employees. Certain formulas can be used to skew benefits to the owners or key employees of the company.
Money Purchase Plans have required contributions. The employer is required to make a contribution to the plan each year on behalf of the plan participants.
With a Money Purchase Plan, the plan states the contribution percentage that is required. For example, let’s say that your Money Purchase Plan has a contribution of 5% of each eligible employee’s pay. You, as the employer, need to make a contribution of 5% of each eligible employee’s pay to their separate account. A participant’s benefit is based on the amount of contributions to their account and the gains or losses associated with the investment of such account through the time of retirement.
A 403(b) Plan (also known as a “Tax-Sheltered Annuity” plan or “TSA”) is a retirement plan that is only permitted to be offered by public schools and certain charities. In many ways, it’s similar to a 401(k) plan maintained by a for-profit entity. Just as with a 401(k) Plan, a 403(b) Plan lets employees defer some of their salary into individual accounts. The deferred salary is generally not subject to federal or state income tax until it’s distributed.
Eligible employers include:
- public school(s), college(s), or university(s),
- church(s); or
- charitable entity(s) tax-exempt under Section 501(c)(3) of the Internal Revenue Code
The status of an employer as a governmental entity as well as the level of employer involvement determines whether a 403(b) Plan is subject to ERISA. Non-governmental status along with significant employer involvement is necessary to fall subject to ERISA.
A Non-ERISA 403(b) Plan results when an employer is either a governmental entity or is not significantly involved in its establishment, operation or maintenance. Non-Governmental , Non-ERISA 403(b) Plans generally allow the employee to choose the investment type while the employer simply collects the money from the employee and remits it to the Plan’s custodian of assets without any other employer involvement.
Under the Traditional Defined Benefit Pension Plan, an employer promises to pay their employees a specific benefit for life beginning at retirement. The benefit is calculated in advance using a formula based on age, earnings, and years of service.
A Cash Balance Plan is a Defined Benefit Plan that looks like a Money Purchase Plan. Like a Money Purchase Plan, fixed contributions are credited to each participant at the end of each year. In addition, participants receive interest credits based on the interest rate defined in the plan. The credit is a fixed rate specified in the plan. Increases or decreases in the value of the plan’s investments do not directly affect the benefits promised to the participants. The investment risks and rewards are borne solely by the employer. The plan maintains a hypothetical account balance for each participant. When the participant retires, his benefit is the value of the hypothetical account. This lump sum value can be converted to a monthly pension at retirement.
A Cash Balance plan is a Hybrid Plan. It appears to participants as a Defined Contribution Plan but is treated under the Internal Revenue Code as a Defined Benefit Plan. Participant statements look like a Defined Contribution Statement. It has a Beginning Balance, Contribution Credits, Interest Credits and an Ending Balance.
A Cash Balance Plan can be used to help skew benefits to a select group of employees. This makes this type of design more powerful than a Traditional Defined Benefit plan in certain circumstances.
To enable larger contributions, especially for Principals and Owners, Cash Balance Plans can be combined with 401(k)/Profit Sharing Plans. The 401(k) and Profit Sharing components can provide additional allocation flexibility to the combined plans.
A 457(b) Plan is a type of Non-Qualified Tax Advantaged Deferred-Compensation Retirement Plan that is available for certain governmental and non-governmental tax-exempt employers. The rules associated with such plans vary greatly depending upon the status of the plan sponsor as either a governmental or non-governmental tax-exempt employer. 457(b) Plans can allow employees to defer compensation into it on a pre-tax basis. The plan can also be designed in order to permit employer contributions.