What kinds of plans are out there? With over 65Million+ results when you Google "qualified retirement plan", there are only 7 different plan types. Some are flexible, some provide guaranteed benefits, some can have life insurance ... in this episode we discuss the pros and cons of the 7 different plans, and how they work together (or don't!) We break it down for you, to give you the gist without being overwhelmed.
What kinds of plans are out there? With over 65Million+ results when you Google "qualified retirement plan", there are only 7 different plan types. Some are flexible, some provide guaranteed benefits, some can have life insurance ... in this episode we discuss the pros and cons of the 7 different plans, and how they work together (or don't!) We break it down for you, to give you the gist without being overwhelmed.
This episode focuses on the letter T: Types of plans.
Episode T: Types of Plans For all of the articles, websites, blogs, technical documentation, and fliers out there – and there are plenty! – there are only 7 different qualified plans that a business owner can sponsor. 7 – that’s it. And with a few basic pieces of information, we can generally nail down which one would fit your business. That’s not saying that we can get the proposal right on the first try, usually theres a few iterations to adjust the total amount going in, or someone’s pay or contribution, but the TYPE of plan and level of contributions? That we can pinpoint. How do we do that? Let’s talk it through.
· First Q – do you need flexibility with your contributions? Or, put another way, can you commit to a certain payment going forward? These plans need to be in place for 3-5 years – so you and your CPA should come up with the answer to that question. If the answer is no, you can’t commit to a dollar amount every year for the next 3 years, then you’re looking at one of the 4 defined contribution plans. Let’s talk about them first.
· The 4 plans are: SIMPLEs, SEPs, Profit Sharing, and 401(k) Safe Harbor Profit Sharing. Common features of these are their flex contribs – max out one year, put in nothing the next – it’s great if your income bounces around a lot. As a result though, no guaranteed ben at ret, since don’t know what contribs will be. Fairly low contribution limits too, good if not looking to max out.
· So what’s the difference between these 4? 2 of them allow employees to contribute too - SIMPLEs and 401(k) PS This is a great way to engage your EEs and to get them saving for retirement. But if you allow employees to defer a part of their pay, it adds some administrative efforts – you need to get them enrolled, get it set up with your payroll provider, provide information on the investments available… as an owner, you’ll need to decide if this is worth it or not. Some owners think “you know, I don’t want all that noise – I’d rather just have the contributions be from the business, I can choose investments, nice and clean” – others say “of course I want a 401(k) piece, that would be great for the ees, a little more time and effort is worth it”. Totally up to you – SIMPLE and 401kSH PS have the EE deferrals, SEP and PS don’t.
· FF: There were nearly 555k 401k plans in 2016, covering about 55M American workers! Not saying all of those ees are contributing, but they do have ability to contribute if they want.
· By 2 Qs, get down to 1 of 2 plans. No ee deferrals – what’s diff between SEP and PS? All the IRS limits are the same – a few main differences. SEP – everyones contrib is same % of pay – can go up and down year to year, 20% one year and 3% next, but all the same, so no skewing bens to owners. Same formula – nobody is being discriminated against, so no administration needed. PS can use diff formulas, push more of total to owner – because diff formulas, need an admin to test to be sure not giving owner too much – additional cost. SEPs go into IRA, which means no LI as investment – PS can have LI up to limits (Listen to Ep L for more details on Life ins in a plan). SEPs are immediately vested – as soon as contrib in, EE can leave and gets it. PS can have a vesting schedule, says how long ee has to work in order to be elig for ben. Finally, SEPs cover part time ees, where PS can exclude anyone not working 1,000 hours. In gen? No ees – SEP is great. EEs – usually skewing to owner far outweighs cost of admin, so PS better.
· Want ee deferrals - diff between SIMPLE and 401k PS? First, 401k PS is simply a PS plan with a 401k component, so all of the PS features hold true. So – differences. W SIMPLE, $ goes into an IRA, so no LI, where 401kPS can use LI up to limits. SIMPLE - contribs are the same for everyone, no admin needed. 401kPS can use diff formulas, so need admin. SIMPLE covers PT ees, 401k PS can exclude less than 1,000 hours. SIMPLE have immediate vesting, PS piece of 401k can have a vesting schedule. Just the PS piece - the 401k piece is always vested, that’s ee money.
· One addl piece that can be added to a 401kPS is a SH contrib. Lots of tests to make sure too much $ not to owner, too little to EEs. Sometimes owners put in more than they should w a 401k – esp if ees arent’ deferring much – get $ returned to them (which is then taxed as income). Avoid this by adding SH contrib – either matches what EEs put in, or it’s a flat 3% - either way, this is a promised ben, and allows owners to put in as much as they want to a 401k w/o worrying about $ being returned. 2 things w these SH contribs – needed every year, so flexibility goes down – can’t put in $0 if you want to, need to put at least this in. 2nd – these are fully vested, ees are elig to take the$ the minute it goes in (discuss vesting in Ep V)
· So, plans diff by investments, formulas for owners vs ees, whether owner wants ee deferrals, vesting schedules and elig. But all of them offer flexible contribs. One note on SIMPLEs and SEPs – if SIMPLE in place, no other plan available for that year – need to term by 11/1 in order to have diff plan the following year. If SEP, don’t’ have to term it, but can’t contribute to both SEP and other plan for same tax year.
· When does this matter? When answer to the very 1st Q is “Yes, I can put in a fixed amount each year”. Then we focus on 3 different types of defined benefit plans. But – you can have a PS, or a 401k PS, with a DB plan. Can’t have SEP or SIMPLE.
· Covered the 4 DC plans - in our original Q – can you put in a set amt - if answer is yes, then the other 3 plans come into play, which are DB plans. The plan document defines a benefit out at retirement, and get to that ben w contribs and int. Ben is guaranteed, so these plans are great for a business owner looking for a specific amt at retirement (Ep G for guarantees). Required contribs each year, need to be able to commit to that. Much bigger contribs than DC – allows 20-30 years of savings to be squeezed into 10 – but w bigger contribs and ded comes less flexibility.
· FF: After new tax legislation in 2018, lots of articles about how DB plans are ‘new tax dodge for rich owners’ – plans around since 1974, nothing new about them! Rich owners? No, owners that have income that they can contribute and not need for a few years due to IRS requirements. Even media that says they’re impartial tend ot put a spin on one way or the other!
· Diff? 412€(3), 412i, fully insured – full investment w LI products. Either all annuity, or part ann part WL. Ann must be fixed or fixed indexed. No variable, no UL, no term. In these, contract between ptps and LI co – one contribution amt, zero flex. Guaranteed by LI co, no market risk on owner – risk w LI co, can get ann and LI out when you retire or terminate – then you’re a contract holder w life ins co. No flex – does offer highest contribs, if owner looking for max contribs and ded. Why? Promised benefit at ret is paid for by contribs and int. LI cos are nothing if not conservative – promised int low, so contribs higher. As high as over 300k per year per owner, in the right situation. All ptps get same formula, % of pay at ret (similar to Social Sec). No skewing - get very pricey very quickly – gen not seen for biz’s w more than a few ees.
· CB is next, pretty popular for biz w ees. Looks like savings acct – ben defined in doc with set contribs and set interest, Rolls forward to ret date, that’s the promised ben. Interest is promised in doc, regardless of what the money actually earns. Usually set between 2-4%, conservative – don’t want it too high, if you don’t earn it – must put in more. Formulas diff by job classes, skew bens to owners. Not as rigid cont wise as 412 – will have a range – min and max but must contribute in the range. Need pension actuary to calculate the range, may have addl admin costs – 412 doesn’t have this, because amts are determined by the ins contracts. Lower contribs than 412, but still a lot bigger than the DC plans – up into the 200,000 mark per year for an owner. Flex w investments – market investments, life ins – not restricted to ins products. Often combined w PS plan (w or wo 401k) for our required testing to be sure owners don’t get too much (discussed more in ep A). Way math works, often can provide much more, if not all, of bens to owners in CB plan, w lower amounts to ees in PS plan, getting 80-90% or more of total contrib to owner. Think about it – say we get 90% of total to the owners. If they’re in top tax bracket, means provide 37% to the IRS, or 10% to their ees. Pretty good choice!
· Final plan is trad DB – sim to 412 because ben is % of pay at retirement, but flex investments and range of contribs like CB. Range usually bigger than CB, but formula is a little harder to understand – CB is so easy because it looks like a savings acct.
· For our final fun fact, we’ll end with the best known DB plan out there – SS. The SS act was signed by FDR on Aug 14, 1935. Taxes were collected for the first time in Jan 1937, and the first one-time LS pmts made that month too. Reg monthly bens started in Jan 1940.
· Wrapping it all up – only 7 plans out there, nuances pros and cons to each. DC plans flexible, lower contribs, not guaranteed, may have EE contribs. DB required contrib but larger contribs, guaranteed ben, no ee contribs. What’s best for you and your business? Let us know what your prioriites are, and we’ll take a look. Proposals are free, so there’s no harm in looking – and we can do them ‘blind’ – don’t need co name or ees names, but we will need specific pieces of info. Happy to help you see what’s out there for your business.
· Want to hear more? The other episodes mentioned here are A (ABCs of QPs), G (guarantees), V (Vesting) and L (Life ins in a plan)
· Have any questions? Shoot me an email at MRS@gmail.com. Thanks for listening in – and have a great rest of your day.