For many new Plan Sponsors, and even those savvy at running company retirement plans, understanding plan design can be daunting. Industry terminology, IRS code sections, and complicated illustrations can make understanding difficult.
As a retirement plan service provider, we try to ensure that your plan design is the most optimal for your group of employees. Since employee demographics can change, it’s a good idea to understand the basics and review your design from time to time.
Permitted Disparity
Other than the desire to provide a retirement plan to benefit all employees, a very common question is asked, “What can be done for the owners of highly compensated employee groups (HCE)?” Since Social Security limits the amount of compensation that is used to calculate benefits (called the Taxable Wage Base), those that earn over the wage base can expect that their benefit in retirement will be a smaller percentage of earnings than that of those who earn less than the limit.
For this reason, the IRS regulations allow for some “permitted disparity” in contribution or benefit amounts between two groups; highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). So, if a company desires to provide additional benefits to all or a portion of their HCE group, what are some of the possibilities?
Maximum Limits
During initial plan design, plan service providers hear “our HCEs would like to receive the maximum contribution allowed in their accounts.” Depending on the type of plan and plan design, this number can mean very different things. It can simply mean maximizing the annual 401(k) limit of $19,000 ($25,000 with catch-up contributions for those who attained age 50). However, by contributing additional funds in the form of a profit sharing, matching, or safe harbor contribution, an individual can receive up to an additional $37,000 in his/her account in a plan year. That brings the “maximum contribution” to $56,000 ($62,000 for those who have attained age 50). Of course, there are required allocations to non-HCEs to comply with the law, but many times these allocation formulas can help your HCE have adequate savings for retirement.
In addition to 401(k) plans, there is the world of Defined Benefit plans. Traditional Defined Benefit Plans focus on providing a monthly benefit in retirement instead of the accumulated account balance received from a 401(k) plan. Cash Balance Plans, while still a Defined Benefit Plan, use individual participant accounts to credit contributions and interest and can even be combined with a company’s 401(k) plan in order to minimize the additional contribution cost. Since regulatory limits are imposed on the benefits calculated in these types of plans, contributions, especially for business owners over age 50, can well exceed the $56,000 currently imposed on individual accounts in a 401(k).
So, be sure that your current plan design is right for you. Contact us with questions about your plan design.
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