If you're a business owner and Google "qualified retirement plan", you get over 62million hits - how would you ever be able to figure out which plan is best?
We'll do it for you!
We take our 25+ years of experience, and let you know what's out there, the pros and cons of each, and why you may want to choose one plan over another. We also discuss using life insurance within the plan to cover part, or all, of a buy/sell for the owners.
This episode uses a hematologist's office as a case study, with two owners and 150 employees. This could also apply to any other office with a similar structure - a few owners, a few other highly paid employees, and a lot of rank and file employees having different roles.
Interested in seeing a proposal specifically for you and your business? Contact us at MonarchFinancialAdvisors@gmail.com - let's see what we can do!
If you're a business owner and Google "qualified retirement plan", you get over 62million hits - how would you ever be able to figure out which plan is best?
We'll do it for you!
We take our 25+ years of experience, and let you know what's out there, the pros and cons of each, and why you may want to choose one plan over another. We also discuss using life insurance within the plan to cover part, or all, of a buy/sell for the owners.
This episode uses a hematologist's office as a case study, with two owners and 150 employees. This could also apply to any other office with a similar structure - a few owners, a few other highly paid employees, and a lot of rank and file employees having different roles.
Interested in seeing a proposal specifically for you and your business? Contact us at MonarchFinancialAdvisors@gmail.com - let's see what we can do!
Welcome to Retirement A to Z, I’m Sue Burnett w Monarch Financial Advisors, and this series focuses on Qualified Retirement Plans. There are a lot of moving pieces with these plans, and the rules are complicated and complex, so we’re going to break them into smaller pieces – 26 pieces, to be exact, from A to Z, with maybe a few extras thrown in for good measure.
This is one of the Episode J’s – just for you! We’re focusing on what retirement plans are appropriate for a particular business, based on answers to a few simple questions: what industry are you in, how many owners do you have, and how many employees do you have. That’s it! If it’s just you and your spouse, that counts as no employees, by the way – your spouse would be considered an owner, solely because they’re married to you.
In this episode, we’re going to focus on a larger business with 150 total employees and the case study is for a group I worked with a few years ago – a hematology group, where there are two owners, a husband and wife, 8 high-paid employees earning over $130,000 (this is an important piece of info, which we’ll talk about in a minute), and 140 rank and file employees, most of which are full time but 40 or so were part time, a day or two a week. The employees have varying job responsibilities – there’s nurses, receptionists, billing folks, office managers, etc in this case study, but in any similar organization, there would be a bunch of different roles, which is also important to our design.
Our first fact is about who we need to include. Anyone working under 1,000 hours per year can be excluded from the plan for now, which means that our 150 total now does down to 110, if we kick the 40 part timers out. Also, you can always discriminate against highly paid employees – the IRS and Department of Labor don’t want the high paid people to get too much, and don’t want the rank and file to get to little. So you can always decrease the amounts going to the high paid employees. Because we have 8 of them that are nonowners, we can exclude them from or plans fully as well. With most benefits paid as a percent of pay, this will save our owners quite a bit, if they’re good with excluding them. Generally the high paid employees are pretty important to the business, so if they’re not given a pension benefit in the plan, the owners may want to consider paying them a bonus outside the plan, to make up for it. More on Eligibility can be found in Episode E.
What are the options for this office? The first would be to have a 401(k) profit sharing plan. This is a defined contribution plan, where each year, the two owners decide what contribution amount should go in to the profit sharing piece, and each employee can choose to defer into the 401(k) piece. Let’s talk about the profit sharing piece first, which is fully funded by the business. The profit sharing amount is flexible from year to year, so if your business wants, or needs, flexibility with how much is contributed, this is a great option. It’s possible that we can give over 25% of pay to the owners, and only 5-7% to the employees – but with 100 employees, this may be pretty expensive, and we may not be able to give the owners a majority of the benefit. If the owners pay bonuses into the plan, instead of paying them directly to the employees, this plan may work out really nicely – there’s no payroll or social security taxes paid on the contribution, and employees need to stay with the company for a set number of years until they’re vested in the benefit – Episode V talks about the different vesting schedules that are available. The contribution needs to be made by the tax filing date with extensions in the next year, but no later than September 15 – so, for 2020, you’d have until you file your taxes in 2021 to make the contribution.
Having a 401(k) piece for the employees is fairly common for businesses of this size
If the owners want to contribute more than 25% of total pay, or more than $57,000 in a year for each owner, you can’t do that in this plan. Also, there’s no guarantee as to what this balance will be at retirement, because you could put in a lot in one year or nothing the next. And finally, with that many employees, it’s pretty unlikely that we’d be able to really skew the benefits for the owners. So if any of these cons outweigh the pros, we need to move onto option 2 – a cash balance plan, layered on top of a profit sharing plan.
A cash balance plan is a defined benefit plan, where there’s a guaranteed benefit at retirement, based on a formula in the plan document. Contributions can be upwards of $250,000 per year for each owner, if their ages and pays allow for that. These really help accelerate their retirement savings, and will help provide a known level of income when the owners decide to retire. This plan is combined with a profit sharing plan for all of our testing, to be sure the plan doesn’t discriminate too much in favor of the owner – it’s usually called a combo plan. Most of the benefits for the owner are in this cash balance plan, where we have the nice high contribution amounts, and most of the benefits for the ees’ over in the profit sharing side. The amounts for the owners increases substantially, because that cash bal plan has a much higher contribution – and much higher deductions. If the business is looking for larger contributions and deductions, this plan would be the way to go. Also, we can fully exclude a lot of different job classes in the cash balance plan, so that there isn’t a lot of extra contributions going for the employees. So what’s the down side? The owners have to make a contribution every year, and there will be higher administration costs because two filings and additional testing need to be done. We would set the overall contribution to be in a range that the owners and their CPAs are comfortable with, and we can always put more into the profit sharing side or into the 401(k) account if there’s a good year and the owners want additional deductions.
Now let’s talk about our case study. Our next fun fact is about what a hematologist does – hematology is the study of blood and it’s basic components – red blood cells, white blood cells, etc. A hematologist studies and helps treat blood malfunctions and diseases, like anemia. Not that this is important to our examples, here, but it’s a fun fact to know!
Our hematology group didn’t have any retirement plan, and had looked into a 401(k) profit sharing plan. They weren’t thrilled with the low contributions for themselves, and the small percentage overall that went to them in the plan, so we created a combination plan for them. They excluded all 8 of the other high paid employees, who were other doctors, as well as all but one of the job classes in the office – this job class had 50 employees, who were the youngest, lowest paid employees with the highest turnover. This group, and the owners, were the only ones in both plans. The end result was that over $500,000 was contributed to the plan, each year, for those two owners, and less than $40,000 was contributed in total for the 50 employees. Almost 93% of that contribution went to the owners, and with the high turnover, very few of the employees every became eligible for full benefits. Were the other employees upset? Maybe, but the owners argument was that the plan was for their retirement, and that the pay, bonuses, and other benefits more than made up for it.
Note that I didn’t say anything about a SEP here. A SEP doesn’t really work for a business like this for a few reasons – first, a SEP requires that the same percent of pay is contributed for each person, including owners, so there’s no skewing the benefits to the owners. Next, a SEP doesn’t allow employee contributions, so if youre looking to add a 401k piece, that can’t happen. SEPs are immediately vested, which means that if an employee has only worked there a year, gets a contribution, and quits, they can take the whole amount with them. And finally, if a business has a SEP, they can’t have any other QP – so, no CB would be allowed for those add’l contribs and deductions. If you’re looking to maximize retirement savings and deductions, a SEP falls short in a lot of ways.
One addl point I’d like to make is that these 2 owners included life insurance in the cash balance plan as an investment. They wanted insurance on each other anyways, and by putting it in the plan, they could pay premiums pretax. If one of them passed away, the other could use the money to hire a new partner, or to retire early and sell the business. So not only did the owners get large deductions and a big boost in retirement savings, but they also could use the plans for business planning purposes. Check out Episode B for more details on business planning with qualified plans, and Episode L, for life ins in a plan.
Wrapping it up – when it comes to qualified retirement plans, there are really 2 choices available for an office with this many people – a profit sharing plan with or without a 401k piece, which is easy and flexible, or a Cash balance plan plus a profit sharing plan to give the owners higher contributions, higher deductions, accelerated retirement savings, and a guaranteed benefit. And, when it comes to who’s in the plan, there’s a lot of flexibility with who is included (or not), and how much they’re given. Give us a call and we can run some proposals for you to see how things shake out – it’ll give you a sense of what’s possible.
Wanna learn more? Tune into the other a to z podcasts where we continue to break down these wonderful and complex plans into bite size pieces. Remember, how do you eat an elephant? 1 bite at a time. Have any questions? Shoot me an email at MonarchFinAdvis@gmail.com. Thx for listeining in and have a great rest of your day!