How to choose the right retirement plan for you or your clients

When choosing a retirement plan, you should carefully consider the goals involved. It could be any combination of tax deductions and tax-deferred growth, retirement fund building, asset protection, attracting and retaining employees, or perhaps some other deduction.

There are two types of retirement plan categories: defined benefit pension plans and defined contribution plans. Before the DC plans, the primary vehicle for retirement savings was the DB plan. Employers would finance a pension and employees would benefit from a guaranteed stream of income during retirement. Fast-forward a few decades after the introduction of the 401(k) plan, and you’ll be hard-pressed to find an employer that offers a DB plan. The reason is simple: cost. The guaranteed aspect of a DB plan is onerous and, in some cases, detrimental to the health and longevity of the sponsoring employer.

So how do you decide which plan is the right one? Start by asking a fundamental question: What are you trying to accomplish? There are several reasons to implement a retirement plan: tax deductions and salary deferral; accumulation of retirement assets; employee attraction and retention; your business is a high risk profession and you want to protect what you have earned through an inviolable trust; and education and orientation of participants. These are not the only reasons, but they tend to top the list.

As a corporate retirement plan advisor, I urge people to do two things. First, meet with a fiduciary advisor who specializes in the retirement plan space, putting clients’ best interests at the forefront. Second, check with your tax advisor, the person who knows more about your financial situation than anyone else, apart from you, of course.

These steps can help you determine which retirement plan option is right for you, based on your current facts and circumstances.

401(k) Profit Sharing Plan

401(k) and profit-sharing plans may be separate. But by combining the two, you create plan administration and rate efficiency. The 401(k) accommodates participants’ salary deferrals, either on a pre-tax basis or as Roth contributions. The maximum salary deferral for participants in 2022 is $20,500. And if the person is age 50 or older, they can defer up to an additional $6,500 of salary as a catch-up contribution. Employers may provide a discretionary or non-elective matching contribution (eg, profit sharing). Total contributions from all sources (e.g., salary deferral, match, and profit sharing) cannot exceed $61,000 for plan year 2022.

This is a basic 401(k) profit sharing plan. Through plan design, you can include significant enhancements such as safe harbor contributions, advanced profit-sharing options, automatic enrollment, and escalation with an opt-out feature. The 401(k) profit-sharing plan offers the greatest flexibility and opportunity for salary deferral for all participants and company-weighted contributions for specific participants.

cash balance

The cash balance plan is essentially a DB plan, with a few differences that may make it more acceptable to business owners. It is often used by businesses comprised of owners or smaller groups with significant cash flow interested in maximizing the retirement savings of selected individuals, usually the owners. It also provides a significant benefit to the employee base. It can be a stand-alone plan or combined with a 401(k) profit-sharing plan, which maximizes the tax deduction and contribution benefit. Annual contributions for business owners can reach a few hundred thousand dollars.

But with a DB plan, the plan sponsor is required to make annual contributions. Additionally, through plan design, you can create a cost-benefit scenario that maximizes benefit to key employees (eg, owners, officers) while minimizing total contribution expense for remaining eligible employees.

401(k) plan for owners only

Only owners and spouses of owners can participate here. Provides discretionary deferral of wages and profit sharing. Can be combined with a cash balance plan, creating additional tax benefits and retirement savings.

Simplified Employee Pension (SEP)

Often used by small businesses or self-employed individuals, SEPs only allow employee contributions, not to exceed 25% of earned income. In the year contributions are made, they must be provided to all eligible employees. The owner contributes to a SEP IRA and the participants invest the money. They are very easy to administer and have no employer filing requirements. However, no career counseling education or guidance is typically provided to participants.

Savings Incentive Matching Plan for Employees (SIMPLE)

SIMPLE 401(k): This is a cross between the SIMPLE IRA and the traditional 401(k) plan. It is available to employers with fewer than 100 employees and is much less complicated to administer and manage. The maximum deferral of a participant’s salary in 2022 cannot exceed $14,000, and the maximum catch-up contribution is $3,000. In addition, employer contributions are mandatory. It can be a 100% contribution on the first 3% a participant chooses to defer or a non-elective contribution of 2% of the employee’s eligible contribution. This is a “simplified version” of a traditional 401(k) plan.

SIMPLE WRATH: This is similar to a SIMPLE 401(k) with a couple of key differences. First, an employer who chooses to match can reduce the amount to less than 3% but no less than 1% two out of every five years. This is not allowed in a SIMPLE 401(k). Second, loans are not allowed in a SIMPLE IRA. However, they are allowed in a SIMPLE 401(k) plan and a traditional 401(k) plan.

403(b) plans

This allows salary deferral and employer contribution for those employed in government agencies, educational institutions and non-profit organizations. It is not subject to the Employee Retirement Income Security Act of 1974, unless there is an “employer-name participation,” such as an employer providing a contribution to eligible participants.

Individual Retirement Account (IRA)

This is a non-business retirement account, which means people with income from work can open an IRA and save for retirement. Employer-sponsored benefits should be maximized first, and then consideration should be given to funding an IRA. This option can be set up as a traditional IRA or a Roth IRA.

conclusion

Due to the many options available, along with the levels of complexity of each, it is strongly recommended that you consult with a corporate retirement plan specialist willing to sign up as a plan fiduciary and with your tax advisor to determine the best plan.

This article does not necessarily reflect the views of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or their owners.

Author Information

Michael A. Abate, FIA, SDRC, directs the corporate retirement plans practice at EisnerAmper Wealth Management & Corporate Benefits, LLC.

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