Retirement plans have become a valuable tool for businesses aiming to attract and retain top talent in today’s competitive job market. Not only do these plans offer employees financial security for their future, but they also provide significant tax benefits. This article explores the reasons why employers should consider providing retirement plans to their employees and highlights the advantages of a floor-offset defined benefit plan.
Tax Benefits of Retirement Plans:
One of the primary advantages of retirement plans is their ability to help employees save money on taxes. Various types of retirement plans, such as 401(k) plans, defined benefit plans, and cash balance plans, offer different tax benefits.
For instance, contributions to a 401(k) plan are deducted from an employee’s taxable income, resulting in reduced tax liabilities. Some 401(k) plans even provide a Roth option, allowing employees to make after-tax contributions and withdraw them tax-free during retirement. Defined benefit plans and cash balance plans also enable employees to benefit from pre-tax contributions, further lowering their tax obligations.
Attracting Top Talent:
In an increasingly competitive job market, businesses need to offer attractive compensation packages to recruit and retain top talent, including professionals such as doctors, dentists, and lawyers. A comprehensive retirement plan can be a crucial component of such a package. The tax advantages associated with retirement plans make them particularly appealing to high-income individuals who may be in higher tax brackets.
Vesting Schedules and Employee Retention:
Retirement plans can also help employers retain talented employees through the use of vesting schedules. Vesting refers to the time an employee must work for a company before they become fully entitled to the employer’s contributions to their retirement plan. By implementing vesting schedules, employers can incentivize employees to stay with the company for a longer duration.
For example, a vesting schedule may require five years of service before an employee becomes fully vested in the employer’s contributions. This encourages employee loyalty since leaving the company before reaching the vesting threshold would result in only partial entitlement to the employer’s contributions. Vesting schedules contribute to employee retention and help businesses retain top talent.
The Floor-offset Defined Benefit Plan:
A floor-offset defined benefit plan offers an advanced pension plan design that combines a defined benefit plan and a profit-sharing plan. This approach allows business owners to maximize their own contributions while providing minimal required benefits to employees.
Under this plan, the business owner receives the maximum benefit through the defined benefit plan, while employees receive a minimum benefit through the profit-sharing plan. The benefits earned in both plans are tested for non-discrimination and compliance with IRS regulations. This innovative design enables business owners to contribute significantly to their retirement savings while maintaining low allocations for employees.
How does this design work exactly?
Let’s consider a hypothetical scenario to better understand the concept of a floor offset plan. Imagine you’re the owner of a small business with five employees and a decent amount of available cash flow. You recently turned 50 and are disappointed that, despite a successful decade in business, you’ve only managed to accumulate $500,000 towards your retirement goals. You desire higher contributions each year while minimizing allocations to your employees.
Someone has mentioned a defined benefit plan to you. However, because you have employees, you must also provide a retirement plan option for them. If you include your employees in the defined benefit plan, you’ll end up contributing a significant amount of money to their retirement accounts, to the extent that it may not make financial sense for you to sponsor the plan.
This is where a floor offset plan comes into play.
The IRS allows for segmentation in a defined benefit plan, which means individuals can be assigned to different classes based on job title, location, and other factors. As the owner, you would be in class 1, while the non-owner employees would be in class 2. The IRS also permits different allocation formulas for each class. Typically, the allocation formula is a percentage of compensation that will be earned in retirement. This formula determines how much money you can accumulate as the owner and how much you need to contribute towards your employees.
As the owner, you can choose to receive 100% of your compensation, up to a cap of $250,000 (adjusted annually), each year after retirement. You can also structure the plan so that employees receive 5% of their compensation as retirement benefits. This initial step helps reduce costs. However, the floor offset plan takes it a step further.
A profit-sharing plan is designed to complement the defined benefit plan. Every employee is allocated a minimum of 5% of their pay in the profit-sharing plan. These profit-sharing allocations are then used to “offset” the benefits employees receive from the defined benefit plan. In many cases, the benefits from the defined benefit plan are fully offset, and employees receive only the 5% contribution from the profit-sharing plan. When we mention “offset,” it doesn’t mean deducting the profit-sharing allocation from the defined benefit plan. It involves complex financial calculations that project everyone’s benefits to a assumed retirement age (e.g., 62 or 65) and offset them at that point.
There’s also the added complexity of cross-testing benefits and contributions. As a third-party administrator, we handle these intricate calculations on your behalf. We utilize advanced software and actuarial expertise to achieve optimal allocations for our clients.
If you have employees who are older than you, their benefits may not be entirely offset. These employees will receive the profit-sharing allocation and the remaining benefits that were not offset from the defined benefit plan.
The floor offset plan is likely the only plan design that allows you to contribute a substantial amount to your own retirement savings while keeping employee contributions in the 5-7.5% range. Here’s a real example of a floor offset plan in action, designed for one of our relatively young clients.
Conclusion:
Retirement plans have become a vital component of an employer’s compensation package, aiding in attracting and retaining top talent. The tax benefits associated with retirement plans make them particularly appealing to high-income individuals. Additionally, vesting schedules encourage employee loyalty and provide long-term benefits to both employers and employees.
For business owners seeking to maximize their own retirement contributions while offering retirement benefits to employees, a floor-offset defined benefit plan can be a highly effective solution. This plan design allows for substantial contributions for the owner while ensuring compliance with IRS regulations and providing employees with essential retirement benefits.
By prioritizing retirement plans, employers demonstrate their commitment to their employees’ financial well-being, creating a more productive and satisfied workforce.
