Defined Benefit Pension Plans
Profit Sharing Plans
401(k) Plans
Money Purchase Pension Plans
Non-Qualified Plans
Executive Bonus Plan
S-Corp Owner Plan
Split Dollar Plan
Executive “Excess” Plan
Executive Non-Qualified Defined Benefit Plan
Executive 457 (b) Retirement Plan
Defined Benefit Pension Plans
Overview
A defined benefit pension plan promises participants a certain (or "defined") monthly benefit beginning at normal retirement date. Retirement benefits are specified by a formula in the plan document typically based on factors including length of service and compensation. The annual benefit that may be paid to a participant under a defined benefit pension plan is limited by the Internal Revenue Code; it is the lesser of (a) $170,000 adjusted for inflation, or (b) 100% of the participant's average compensation.
The plan is funded using actuarial calculations that factor in variables such as life expectancy, salary increases, rate of investment returns, cost-of-living adjustments, plan expenses, employee turnover, death, disability, etc. The concept of account balances is absent in a traditional defined benefit pension plan. The participant's accrued benefit in a defined benefit pension plan is the portion of retirement benefits earned thus far.
Advantages
- A defined benefit pension plan provides security to the employee, because accrued benefits may not be reduced or eliminated
- Furthermore, the employer bears the risk of investment loss, not the employee
- Older employees can receive much higher benefits in a defined benefit pension plan than in a defined contribution plan
- The maximum employer deduction amount could also be larger in comparison to a defined contribution plan
- A defined benefit pension plan can use a formula that is integrated with Social Security benefits, and provide higher benefits on compensation in excess of the taxable wage base
- A defined benefit pension plan can be structured to encourage early retirement, providing the company an attractive alternative to mandatory layoffs
- Plan benefits may be made subject to a vesting schedule
- Forfeitures reduce the employer's cost of providing retirement benefits
- With changes in the law stemming from EGTRRA, 2001, an employer can adopt a deferral-only 401(k) plan in addition to its defined benefit pension plan. This allows employees to receive enhanced benefits. The employer can deduct contributions to both plans
- A defined benefit pension plan typically pays benefits in the form of a life annuity, or a qualified joint and survivor annuity. However, plans can also permit optional forms of benefit such as lump-sums and installments
- A defined benefit pension plan may allow for payment of benefits upon reaching normal retirement age, termination of employment, plan termination, disability, or death. Plan loans are also permissible
- A defined benefit pension plan may be adopted by tax-exempt entities, churches and governmental entities, in addition to taxable entities
Possible Disadvantages
- The employer's funding obligation to a defined benefit pension plan is not discretionary or optional. Failure to fund the plan timely results in the imposition of penalties by the IRS
- Employees struggle to understand the concept of a future benefit being currently funded. There is no neatly wrapped "account balance"
- A defined benefit pension plan must take into consideration additional compliance requirements pertaining to minimum participation
- The annual cost of funding a defined benefit pension plan can be volatile, since it is tied among other things to the performance of trust assets
- The funding of a defined benefit pension plan is required to be certified by an actuary. The only exception is a fully insured plan, sometimes called a 412(i) plan
- A defined benefit pension plan is required to participate in the federal insurance program administered by the Pension Benefit Guaranty Corporation (PBGC) and pay annual premiums. However, owner-only plans, and plans sponsored by certain professional service employers with under 26 active participants are exempt
- Participant-directed investment accounts are generally not permitted
- In-service withdrawals are not allowed
Analysis
There exists a common misconception that a plan sponsor is trapped by a defined benefit pension plan once it is established. While it is true that benefits already accrued may not be taken away, the plan sponsor still has a number of options to adjust for shifting financial scenarios and to control costs. It may (a) reduce or eliminate future benefits, (b) close the plan to new participants, (c) freeze the plan, or (d) terminate the plan.
Furthermore, a plan sponsor has a number of choices during the plan's design stage. A defined benefit pension plan can be established as a cash balance plan, or as part of a floor offset arrangement with a defined contribution plan, or aggregated with a defined contribution plan. A myriad of formulas are possible: fixed benefit, flat benefit, unit benefit, and so forth. A number of funding methods are also available such as entry age normal, frozen initial liability, level cost, unit credit, etc. The choice of funding methods has an impact on plan cost.
Conclusion
The United States has a voluntary pension system in which no employer is obligated to offer a pension plan. If defined benefit pension plans are undermined, employers will exit the defined benefit pension system altogether, as many already have.
Nevertheless, a defined benefit pension plan is only appropriate if the employer is confident it will meet its contribution liability every year. For such an employer, a defined benefit pension plan is an indispensable tool for providing retirement security to its employees, and gaining current tax advantages for itself. It is the optimum strategy for older employees who have been deprived of plan benefits during the early part of their careers, or for principals who experience a sudden surge of cash flow.
Back to the Top
Profit Sharing Plans
Overview
A profit sharing plan is a type of employer-sponsored retirement plan maintained with the intention of allowing employees to share in company profits. Nonetheless, the employer is neither required to have profits in order to make a contribution, nor do the contributions need to be made out of profits. Amounts contributed to the plan are tax-deductible to the employer. The contributions accumulate tax-deferred, and become taxable to the employee when distributed, either at retirement, or upon the occurrence of a specified event, such as death, disability, termination of employment, etc. The employer enjoys discretion in making contributions, and has a broad range of options in determining how the contributions will be allocated among various eligible employees.
Advantages
- The employer contribution is completely discretionary
- The employer can use the plan as a motivational tool in allowing employees to share in profits
- A profit sharing plan may allow employee contributions, which can be matched
- Flexibility in the allocation of contributions using any one of a number of formulas: (a) proportionate to compensation; or (b) proportionate to compensation adjusted for Social Security benefits; or (c) age-weighted, considering age and compensation as factors; or (d) a new comparability allocation formula, which allows the employer to maintain flexibility in allocation as long as the results can project and prove comparable benefits are paid at normal retirement age
- A non-profit organization, church or governmental entity may also sponsor a profit sharing plan
- A profit sharing plan may permit early withdrawals (for instance, under certain hardship circumstances) and plan loans
- A profit sharing plan may provide incidental benefits such as life, accident or health insurance
Possible Disadvantages
- The employer is expected to make "substantial and recurring" contributions
- The deduction limit may be lower than in a defined benefit pension plan
- The level of benefits that may be provided is potentially not as high as in a defined benefit pension plan
- There are limited restrictions on the withdrawal of profit sharing funds, for example, generally speaking, the funds must have been in the plan for two years before they can be withdrawn, and only if the document allows it
Analysis
Profit sharing plans have become more attractive since EGTRRA increased the deduction limit in profit sharing plans from 15% to 25% of aggregate eligible compensation. New comparability (tiered) plans offer the appealing option of the employer being able to target certain groups of employees for higher benefits.
Conclusion
Profit sharing plans continue to be one of the most popular types of plans adopted owing to their flexibility in contributions and allocations, as well as their substantial deduction limits. It helps that they are also one of only two defined contribution plan types that allows employee pre-tax contributions. All these factors contribute to the ability of profit sharing plans to be customized for the particular retirement plan objectives of individual employers.
Back to the Top
401(k) Plans
Overview
Truth be told, a 401(k) plan, thus named after the Internal Revenue Code section that describes it, is not a type of plan at all, rather a type of funding arrangement (qualified cash or deferred arrangement) that is part of a profit sharing, stock bonus or pre-1974 money purchase pension plan. A 401(k) arrangement allows employees to defer a portion of their current compensation into a tax-qualified plan to accumulate tax-free, and to be taxed at a subsequent stage when the funds are distributed. These deferrals are non-forfeitable, i.e. 100% vested, and may be matched by the employer, but are not required to be.
Advantages
- The employee is able to defer taxes on current compensation, and the income thereon accumulates tax-free
- The employer gets a current deduction for all contributions made
- A 401(k) plan provides higher contribution limits than an individual retirement account (IRA)
- Wider popularity with the recent increased annual deferral limits, as well as the increased additional annual catch-up limits for employees age 50 and over ($14,000 and $4,000 for calendar year 2005 respectively)
- Employees have individual flexibility over determining the amount of pre-tax contributions to the plan
- Deductible employer discretionary and/or matching contributions may also be made to the plan
- Provides incentive for employees to save for their retirement
- Certain taxpayers may receive a tax credit for some or all of their 401(k) contributions under the Retirement Savings Tax Credit
- Tax-exempt organizations, churches, and Indian tribal governments may also adopt a 401(k) plan
- 401(k) deferrals may be withdrawn for hardships or upon the attainment of age 59 1/2 if the plan document allows. In most cases, withdrawals prior to attaining age 59 1/2 will incur an excise tax
- Most plans allow participant direction of investments. Whether this meets the criteria of an advantage in all cases, is a moot subject
Possible Disadvantages
- Exposure to a plethora of nondiscrimination tests, for instance, ADP/ACP tests, top-heavy tests, etc. This may limit the ability of highly-paid employees, and owners to participate in the plan
- It may make employers lethargic to make corporate contributions, since the plan experiences a steady stream of employee contributions
- Additional fiduciary and administrative burdens relating to participant investment choices
- Elective deferrals directly eat into an employee's available current compensation
- Participants bear the risk of investment experience and investment choice
- In-service distributions of elective deferrals are restricted
- A 401(k) feature may not be provided under a current money purchase plan
Analysis
One of the major frustrations experienced by plan sponsors relates to failed nondiscrimination tests, which limit the ability of highly paid employees and owners to participate in the plan. There are a few options available:
- In an automatic enrollment (or negative election) 401(k) plan, the employee is automatically enrolled in the 401(k) plan upon meeting the plan's eligibility requirements, unless the employee elects affirmatively not to participate. The employee MUST be given the option to elect out. Plans utilizing this method have seen increased rates of participation and contribution. The IRS has indicated that the default contribution rate can be higher than 3%, but studies suggest that the average default contribution rate in these plans is about 2%, and the most popular default rate is 3%.
- Employers may increase non-highly paid employee participation through education, and incentives such as matching contributions, more liberal vesting schedules, etc.
- They may use the prior year testing method, and limit highly-paid employee contributions, based on the results of prior year tests, and thus avoid having to make refunds at the end of the year on account of failed tests.
- The employer may utilize the safe harbor option. Providing certain "safe harbor" contributions exempts the plan from ADP/ACP nondiscrimination testing. In most cases, this also eliminates top-heavy testing.
Conclusion
The introduction of pension law changes through EGTRRA in 2001 makes 401(k) plans even more attractive. Contributions of employee elective deferrals no longer reduce the employer's deduction limits. These modifications allow employers additional creative options.
Firstly, the sponsor of a defined benefit pension plan can now adopt a deferral-only 401(k) plan, and deduct contributions to both plans. Employees can receive enhanced benefits under this arrangement. Secondly, this allows self-employed individuals with no employees to deduct a much higher percentage of their net earned income than previously. By way of example, a sole proprietor with $160,000 in net earned income can contribute $10,000 (more if catch-up eligible) as 401(k) deferrals, and $30,000 as profit sharing contributions, reducing the individual's compensation to roughly $122,500, after calculating self-employment taxes.
The flexibility in contributions and withdrawals continues to make 401(k) plans the number one choice in employer-sponsored retirement plans. Assets in 401(k) plans have increased on average 13 percent per year, from $385 billion in 1990 to an estimated $1.9 trillion at year-end 2003 (Sources: Investment Company Institute, U.S. Department of Labor, and Federal Reserve Board). 401(k) plans now cover an estimated 42 million American workers, and are an extremely valuable means for the employer and employee to cooperate in saving for the employee's retirement.
Back to the Top
Money Purchase Pension Plans
Overview
A money purchase pension plan is a type of defined contribution plan to which the employer makes mandatory tax-deductible contributions according to a pre-determined formula. The formula for allocating the contribution to various employees is generally a specified percentage of each participant's compensation, but other formulas are permitted. The contributions grow tax-deferred, and are taxable to the employee only when they are distributed. The contribution requirement and allocation formula are specified in the plan document. The plan must designate itself a money purchase pension plan.
Advantages
- Offers employees the security of reliable, regular contributions through the course of their careers
- Limitations on in-service withdrawals impose retirement saving discipline, and make it more likely that retirement funds will indeed be used for that purpose
- For planning purpose, the employer's contribution amounts can be determined in advance with a high degree of accuracy
- Flexibility in the determination and allocation of contributions using any one of a number of formulas: (a) proportionate to compensation; or (b) proportionate to compensation adjusted for Social Security benefits; or (c) age-weighted, considering age and compensation as factors; or (d) a new comparability allocation formula, which allows the employer to maintain flexibility in allocation as long as the results can project and prove mathematical equity at normal retirement age
- An employee stock ownership plan (ESOP) can be structured as a money purchase pension plan, but not as a profit sharing plan
- Under the safe harbor rules of Internal Revenue Code section 414(n)(5), if a leasing organization maintains a money purchase pension plan that meets certain conditions, the employees are not treated as leased employees of the recipient employer
- The plan may allow or require employees to make after-tax contributions, but these contributions would have to be tested for nondiscrimination
- Plan loans may be permitted
- Money purchase pension plans are preferred by unions, because they obligate employers to contribute to the plan
- A non-profit organization, church, or governmental entity may also adopt a money purchase pension plan
- A money purchase pension plan may provide incidental benefits such as life, accident or health insurance too
Possible Disadvantages
- Employer contributions are required, and failure to contribute timely can result in the imposition of a nondeductible excise tax
- A money purchase pension plan may not provide for in-service distributions except in the case of plan termination, attainment of normal retirement age, and attainment of age 70 1/2
- The plan must provide benefits in the form of a life annuity (joint and survivor annuity, if married). This requirement creates administrative and fiduciary burdens. In reality though, most participants waive the annuity option
- A money purchase pension plan may not include 401(k) arrangements. The only exceptions to this rule are plans that were in existence prior to ERISA, 1974
Analysis
The passage of EGTRRA, 2001, has diminished the functional value of money purchase pension plans. The increased deduction limit in profit sharing plans has contributed immensely to the declining status of money purchase pension plans. Profit sharing plans now have almost all the features of money purchase pension plans, in addition to discretion and flexibility. Whereas money purchase pension plans covered 1 in 10 defined contribution plan participants in the United States (roughly 3 million employees) in 2002-03, most of these plans were adopted prior to EGTRRA.
If the employer favors the flexibility of a profit sharing plan, its existing money purchase pension plan may be merged or amended into a profit sharing plan with or without a 401(k) arrangement. The employer also has the option to terminate its money purchase pension plan, and allow the plan assets to be distributed or rolled over to another qualified plan.
Conclusion
Money purchase pension plans can serve as safe harbor plans in situations where the employer leases employees but does not wish to cover the leased employees in its own employee benefit plan. Also, money purchase pension plans with zero percent-of-compensation contribution formulas are extremely effective vehicles to receive and shelter retirement money in an employee benefit plan through rollovers and transfers without creating employer liability for contributions [Internal IRS Memorandum from Chief, Employee Plan Technical Branch 2, to District Director, Los Angeles, Key District, Aug 10, 1995]. Therein lies excellent value for certain employers.
Back to the Top
Employee Stock Ownership Plans (ESOPs)
An Employee Stock Ownership Plan (ESOP) is a tax-qualified employee benefit (retirement) plan that is designed to invest primarily in stock or other securities issued by the employer.
An ESOP must be custom designed to fit a company's situation and needs. Typically, an ESOP works like this:
- The employer implements an ESOP by adopting a written ESOP document and by naming a plan trustee.
- The employer then makes tax-deductible contributions to the plan.
- The plan trustee uses the contributions to buy employer stock.
- The trustee holds the stock for the benefit of the participating employees
- When employees retire (or in certain other circumstances), the trustee makes distributions to the employees from the plan. The distributions may consist of employer stock or, under certain circumstances, an equivalent amount of cash.
An ESOP may be set up so that employer contributions provide the funds for the plan's stock purchases. Or a debt-financed - leveraged- form of ESOP. With a leveraged ESOP, the trustee or plan sponsor borrows money from a lender. The borrowed funds are used to acquire stock from the company. In turn, the trustee uses company contributions to gradually pay both interest and principal on the debt. A leveraged ESOP can supply a corporation with substantial working capital funded with tax-deductible dollars. Under the right circumstances, a leveraged ESOP can be a very practical financing resource for a company.
ESOP Benefits include:
- Added stock liquidity - If the employer is a closely held corporation, the ESOP can ensure a market for employer stock. Acquisition and merger assistance - A closely held corporation may use its ESOP to help (or hinder) prospective acqusistions or mergers.
- An ESOP makes employees part owners of the company. So they will benefit from any appreciation in the company's value.
Back to the Top
Non-Qualified Plans
Executive Bonus Plan
Highlights
Complete executive benefit solutions for owners and key employees of growing businesses with an emphasis on bottom-line value and ease of use.
Key Features
- Participants can choose from a variety of producer choices to tailor an investment strategy to meet changing needs and objectives.
- No nondiscrimination testing or government filings, such as Form 5500, are needed.
- A tailored business solution that is tax and administratively efficient.
- Available to all employees; no “Top Hat” requirements.
Employer Advantages
- Provides the ability for you to recruit, reward and retain the key employees who contribute the most to your business' continued success.
- Business receives a current tax deduction.
- Agreements may be added to tie the key employee closer to the business.
- Simple, yet flexible, plan design is easy to communicate and maintain.
- Plan is exempt from annual reporting and ERISA requirements.
Employee Advantages
- Overcomes government limitations on the amount highly compensated employees can save for retirement.
- Receive enhanced retirement and/or survivor benefits.
- Employees own the financial asset.
- Minimal cost. The participant's cost is the tax associated with the bonus. This cost may be partially or fully offset with an additional bonus.
- Overall low tax rates.
Employer Disadvantages
- Asset is not corporate-owned.
- Each bonus paid reduces company cash flow.
Employee Disadvantages
- Additional tax if employer's bonus doesn't cover 100% of the tax.
- Employer's bonus may be contingent on continued employment.
- Depending on financial asset selected, annual taxation of earnings may apply
Back to the Top
S-Corp Owner Plan
Highlights
This concept is a way for owners of S corporations to move cash from the business to the owner personally. Depending on the funding method chosen, the concept can help maximize tax diversification and leverage.
Key Features
- S corporation owner distributed business profit either as an owner dividend or as a compensation.
- Funding products can be chosen which provide supplemental retirement income and provide tax diversification.
- This tailored business solution is unique to S corporations and is tax and administratively efficient.
Owner Advantages
- Provides funding for needs such as retirement, disability and death protection
- Provides flexibility to choose either compensation or dividends as the funding source
- Depending on the funding vehicle chosen, can offer the opportunity for tax diversification planning
- Provides certain protections from creditors in some situations
Owner Considerations - Depending on the owner's tax situation, in some cases it is an issue whether the owner contributions are after tax.
- If there is more than one owner and a dividend design is used, the distributions need to be in proportion to ownership.
- Depending on the financial asset selected, it may be subject to the owner's general creditors.
- Depending on the financial asset selected, annual taxation of earnings may apply.
Back to the Top
Split Dollar Plan
Highlights
A cash value life insurance police is purchased for an employee and paid for with interest-free (0%) loans from the employer. A portion of the cash value and death benefit equal to the loan is assigned to the employer. At retirement or death, the loan is paid off or forgiven and the assignment is terminated.
Key Features
- An efficient way for employers to help employees pay for a key benefit.
- Employers have complete flexibility in deciding which employees will participate.
- Provides enhanced retirement and survivor benefits with minimum employee cash outlay.
- Easy to implement and administer.
- Provides cost recovery for the employer.
- Fully consistent with Split Dollar Final Regulations.
Employer Advantages
- An efficient way to help the employee pay for a key benefit
- Flexible plan design, giving you the option to provide tax-deductible bonuses
- Easy to implement and administer
- Exempt from annual reporting requirements
- No administrative services fees
Employee Advantages
- Overcomes qualified plan limitations on the amount highly compensated employees can save for retirement
- Provides enhanced retirement and survivor benefits with minimum cash outlay
- Employee owns the life insurance policy, subject to an assignment for loan
- Employer may chose to provide bonuses to offset some or all the tax costs on the amount saved - making this a tax-efficient way to save
Employer Considerations
- The insurance policy is not a corporate asset. (However, the collateral assignment offers the employer the ability to reach policy values if a cash emergency arises.)
- Amounts loaned (premium payouts) are not tax deductible.
- Each premium payment and bonus (if provided) reduces annual cash flow.
- If the interest-free loan approach is used, annual fluctuation in interest rates means interest tax-cost bonuses are unpredictable and may increase.
- Publicly owned companies cannot issue loans to employees.
Employee Considerations
- Additional income tax liability if employer chooses not to provide a bonus to cover income taxes due on the loan.
- The collateral assignment (amount of loaned premiums) must be repaid to the employer upon termination of the arrangement (unless the employer waives its right to be repaid) or upon death. The collateral assignment also exposes policy values to the employer's general creditors.
- If the interest-free loan approach is used, the annual interest cost of the arrangement to the employee will vary from year to year as the interest rate used (the federal Blended Annual Rate as published each July by the IRS) is adjusted annually.
- The employer may require repayment of the loan at any time if a demand loan is used.
- Retaining ownership of the policy for retirement income will cause inclusion of the policy death proceeds in the insured's gross estate for estate tax purposes.
- The employee must provide evidence of insurability to qualify for the life insurance policy. The policy includes mortality costs of insurance and surrender charges may apply.
Back to the Top
Executive “Excess” Plan
Highlights
Allows selected executives (who meet the “Top Hat” exemption) the option of deferring up to 100% of their income on a pre-tax basis. Employer can also make discretionary and discriminating matching or incentive profit-sharing contributions.
Key Features
- The ability to design an individualized investment strategy.
- With proper design, plan may be cost neutral over time or even financially beneficial to the company.
- Assets accumulated to finance the plan are held as corporate assets and may enhance the company’s balance sheet.
- Earnings accumulate tax-deferred
- Flexible plan design to meet the needs of specific key employees.
- Plan is simple; no government filings or discrimination testing.
Employee Advantages
- Each executive elects to defer additional compensation in excess of the qualified plan limitations on a before federal and state tax basis - subject to FICA like a 401(k)*
- Earnings in the Executive Nonqualified "Excess" Plan account accumulate tax-deferred
- No excise penalties for early distributions (10%) or mandatory distributions at age 70-1/2
- No annual limitation on contributions. An executive can defer up to 100% of eligible compensation if the company allows
- Tailored investment strategy through self-directed investment accounts
- Internet access to account information - valued daily
- Contributions to the plan may not be tax deductible for state income tax purposes in Pennsylvania.
Company Advantages
- Solves a problem by creating a way for highly compensated executives to exceed all deferral limits in the qualified retirement plan(s) on a pre-tax basis
- Lost benefits due to compensation and deferral limits in qualified retirement plans can be replaced for a specific group of executives selected by the company
- Assets accumulated to finance the plan are held as corporate assets and may enhance the company's balance sheet
- Earnings from the company assets financing the plan may grow tax-deferred depending on the financing option selected
- Can choose to make matching and/or incentive profit-sharing contributions on a per-employee basis
- Simple to administer
Employee Considerations
- No loan provisions
- No rollover provision into an IRA
- Contractual obligation versus fiduciary liability
- Assets are owned by the company and are subject to company creditors
- Election to defer income only once per year in advance of earning income
- Deferrals reduce wages for qualified plan contributions unless coordinated with "Excess" Plan
Company Considerations
- Deferred income tax deduction versus a current income tax deduction
- Potential charge to earnings on the taxable investments or COLI assets purchased to finance the plan
- Plan level administrative service fees
- Human resource time to communicate the plan benefits to eligible participants
Back to the Top
Executive Non-Qualified Defined Benefit Plan
Highlights
A Nonqualified deferred compensation plan where the employer promises to provide a supplemental retirement benefit for a select group of management or highly compensated employees. The company can choose to informally finance the future obligation or leave the obligation unfinanced.
Key Features
- The company can design discretionary and discriminatory incentive benefits to recruit retain and reward valuable key employees.
- The plan can restore lost benefits due to IRS limitations and/or provide supplemental benefits in excess of the qualified plan to help key employees meet their retirement goals.
- Assets accumulated to informally finance the plan remain an asset on the company’s balance sheet.
- The plan requires no nondiscrimination testing, minimum participation or Form 5500 filing, if set up properly.
Employee Advantages
- Plan can restore lost benefits due to IRS limitations and/or provide supplemental benefits to help meet their retirement goals.
- Employees can tailor benefit distribution options to meet their needs.
- There are no excise tax penalties for early distributions or mandatory distributions at age 70-1/2
- Employees are not required to make contributions and do not bear the investment risk of the benefit.
- Employees have Internet access to benefit information and "what if" calculations.
Company Advantages
- Company contributions lost due to IRS restrictions in qualified plans can be restored.
- The company can design discretionary and discriminatory incentive benefits to recruit, retain and reward valuable key employees.
- Assets accumulated to informally finance the plan remain an asset on the company’s balance sheet.
- The plan requires no nondiscrimination testing, minimum participation or Form 5500 filing, if set up properly.
Employee Considerations
- No loan provisions
- No rollover provision into an IRA
- Limited ERISA protection
- Contractual obligation versus fiduciary liability
- Rabbi Trust can help manage this risk
- Assets financing the plan are owned by the company and are subject to company creditors
Company Considerations
- The company takes investment risk by making a promise to pay a defined benefit
- Deferred income tax deduction versus a current income tax deduction
- Accrue future deduction as a Deferred Tax Asset to reflect timing difference
- Potential charge to earnings on the taxable investments or COLI assets purchased to finance the plan
- Administrative service fees
- Human resource time to communicate the plan benefits to eligible participants
Back to the Top
Executive 457 (b) Retirement Plan
Highlights
Nonqualified deferred compensation plans for non-governmental tax-exempt organizations that allow a select group of management or highly compensated employees the ability to make contributions in excess of qualified plan limitations on a pre-tax basis.
Key Features
- Allows “Top Hat” employees to defer additional compensation on a pre-tax basis.
- Assets accumulated to finance the plan liability are held as an organization asset
- The ability to design an individualized investment strategy.
- The organization may finance with corporate-owned life insurance (COLI) or mutual funds.
- If the organization finances the plan with COLI, death proceeds may provide recovery of plan costs and an endowment to finance future plan benefits.
- 457 (b): Allows the total of employee and employer contributions up to ($15,000) (2006) in excess of qualified plan limitations.
- 457 (f): Has no contribution limits; may defer up to 100% of compensation.
Employee Advantages
- Defer additional income in excess of the qualified plan limits on a pre-tax basis
- Accumulate earnings tax-deferred*
- No excise tax penalty for early distributions
- Tailored investment strategy through self-directed investment accounts
- Internet access to account information - valued daily
- Catch-up provisions for employees within three years of retirement
* Contributions to the plan may not be tax deductible for state income tax purposes in some states.
Tax-exempt Organization Advantages
- Provides a way for valuable key employees to defer income in excess of the qualified retirement plan on a pre-tax basis
- Assets accumulated to finance the plan liability are held as corporate assets and should not affect the organization's financial statements
- Can choose to make matching and/or incentive profit sharing contributions on a per-employee basis (subject to the $15,000 overall deferral limit)
- Finances the plan with corporate-owned life insurance (COLI); the organization benefits from the life insurance death benefit
- Internet access to account information - valued daily
- Easy to administer, communicate and maintain
Employee Considerations
- No loan provisions
- The maximum combined contribution for 2006 is $15,000
- No rollover provisions into an IRA (may be rolled into another 457(b) plan)
- Contractual obligation versus fiduciary liability
- Assets are owned by the organization and are subject to creditors
- Nonqualified deferrals may reduce wages for qualified plan contributions
- In the case of bankruptcy, amounts owed to participants in this plan are given the same status as other general creditors of the organization
Tax-exempt Organization Considerations
- Potential charge to surplus on assets purchased to finance the plan
- Plan level administrative service fees
- Human resource time to communicate the plan benefits to eligible participants
This information is intended to provide accurate and authoritative information in regard to the subject matter covered. The accuracy of the information is not guaranteed and is provided with the understanding that Select Portfolio Management, Inc. is not rendering legal, accounting, or tax advice. While this communication may be used to promote or market a transaction or an idea that is discussed on this web site, it is not a marketing opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Back to the Top