How can you take your business’ retirement plan to the next level?
“In the game of retirement planning, there is no hole in one. However, adding a QRP can help your business recruit, retain and reward employees.”
Here’s how professional golfer Doug Sanders once described his retirement plan: “I’m working as hard as I can to get my life and my cash to run out at the same time. If I can just die after lunch Tuesday, everything will be perfect.”
It’ll grab some laughs at the 19th hole, but for many Americans, it’s the plan they have in place—and that’s no laughing matter. As a business owner, how can you build a plan to provide yourself, your partners and your employees with a comfortable retirement?
There are two main types of employer-sponsored retirement plans: qualified retirement plans (QRPs) and non-qualified plans. This article will focus on QRPs.
A QRP is established by an employer for the benefit of the owners and employees and must meet the requirements set out by the Internal Revenue Code (IRC) Section 401(a). These plans give employers a tax deduction for the contributions they make for their employees and present an opportunity for participants to defer a portion of their income into the plan to reduce their present income-tax liability. Plan contributions generally are not taxed until the participant starts to make withdrawals.
As a business owner, what are some of the benefits of your sponsoring a QRP?
- You can use the plan to save for your own retirement on a pretax basis.
- Contributions for employees are generally tax-deductible.
- Plan assets grow tax-deferred and are afforded greater creditor protection.
- A good retirement plan can help your business recruit, retain and reward employees.
QRPs are either defined contribution (DC) or defined benefit (DB) plans. A DC plan does not promise a specific amount of money at retirement. The employer, the employee or both contribute to the employee’s individual account under the plan, sometimes at a set rate, such as 5 percent of earnings annually on a pretax basis. The employee will ultimately receive the balance, which is based on contributions plus or minus investment gains or losses.
In contrast, a DB plan customarily promises a specified monthly benefit at retirement. More commonly, it may calculate a benefit through a formula that considers such factors as an employees’s compensation and years of service.
Two common types of DC plans are 401(k) plans and profit-sharing plans (PSP). For 2019, annual 401(k) contributions are limited to $19,000. An additional $6,000 is allowed as part of a “catch-up” clause for those aged 50 and above.
Profit-sharing plans allow employers to make discretionary contributions depending on profits. There are different allocation formulas that can be used, but for business owners, in many instances, the most favorable is the new comparability plan. Owners closer to normal retirement age may be able to make greater contributions for themselves without having to make the same level of contribution for the staff. For 2019, the limit for defined contribution plans under IRC Section 415(c)(1)(A) is $56,000 annually, so between a 401(k) and a PSP, your contributions cannot exceed this limit (though the limit is increased to $62,000 with the catch-up contribution). Compared to fully funding a 401(k) plan, a max-funded PSP plan provides additional utility to save for retirement.
A cash balance plan is a DB plan that supplements a 401(k) and PSP with substantially larger contributions and associated tax savings. At retirement, employees can either take the lump sum or elect an annuity for monthly payments. Cash balance plans have gained popularity, due mainly to their flexibility and their potential for much larger tax-deductible contributions. It is not uncommon for the owner’s maximum allowable plan contributions to be in excess of $100,000. By combining cash balance plans with a 401(k) and a PSP, business owners can rely on an additional benefit of up to $225,000 per year in retirement. Cash balance plans provide a meaningful way for business owners to save for their retirement. In Doug Sanders’ instance, implementing a cash balance plan might have allowed him time to play more rounds of golf and to order a few more lunches with the additional savings.
In the game of retirement planning, there is no hole in one. However, by adding a QRP to your business, you will get a tax-favored funding vehicle that can provide meaningful tax deductions today and additional financial security in the future.