How can your retirement plan work for you? Aside from saving for your own retirement, that is…
Retirement plans shouldn’t be a one size fits all approach. It should be a strategic tool that helps plan sponsors achieve their business goals. Just as one business differs from another, we see that plan sponsors have many different objectives for offering a retirement plan.
4 Benefits of a company-sponsored retirement plan:
- To offer a competitive benefit package to recruit and retain employees
- To assist employees in reaching a meaningful retirement
- Retaining key employees and executives
- To save for your own retirement as a business owner and reduce taxable income
Plan sponsors commonly review operational aspects of their plan, but we also encourage an annual review to make sure that the plan is meeting its business goals and to evaluate if improvements are possible.
1. OFFER A COMPETITIVE BENEFIT PACKAGE TO RECRUIT AND RETAIN EMPLOYEES
One of the most common goals for offering a 401(k) plan is to recruit and retain employees. According to a recent survey1, 81% of employees stated that retirement benefits offered by an employer will be a major factor in their decision to accept employment.
To ensure that your plan remains competitive, The Trust Company of Tennessee benchmarks plan features against national averages based upon company size and industry. This helps plan sponsors determine the competitiveness of areas like employer match, plan eligibility, vesting schedules, and more.
2. ASSIST EMPLOYEES IN REACHING A MEANINGFUL RETIREMENT
Another common goal for some employers is to help employees in reaching a meaningful retirement. Your employees are the heart of your organization, and they have dedicated their time and effort to help your business succeed. Often, plan sponsors want to help employees accumulate enough savings to ensure that they can retire on-time and comfortably.
Plan design can be a great tool to help structure a plan that will set your employees on a successful path.
- Employer match: Many financial experts recommend that participants save at least 10% of pay (including employer match) to be able to replace their income in retirement when combined with Social Security. By adopting an employer match of 50% of the first 6% contributed, you are encouraging participants to defer 6% of compensation to receive a 3% match. By taking full advantage of the match, they will be close to saving the minimum recommended by many financial experts. Plan sponsors could also explore more generous matches, such as 100% of the first 6% to provide even greater savings potential.
- Auto-features: Behavioral psychology tells us that inertia is strong. Plan sponsors can use this to participants’ benefit by adopting features such as automatic enrollment and automatic escalation. This enables plan sponsors to automatically enroll participants at a pre-determined level of compensation (e.g. 3% of pay) unless they choose to opt-out. Auto-escalation enables participants to slowly increase their deferral over time, without the “sticker shock” of immediately deferring a large percentage of their pay. Each year, their contribution percentage will increase at a pre-determined level (e.g. 1% of pay), until they reach a specified cap (often 10% of pay). Features such as these helps to ensure that participants begin saving and periodically increase their savings amounts without requiring them to act.
- Tax benefits of ROTH: 401(k) plans have traditionally offered tax-deferred growth to participant contributions by allowing pre-tax contributions during an employee’s working career. Taxes are deferred until a participant retires and begins distributions, potentially at a lower marginal tax rate. Every participant is unique and thus, has a different tax situation. Plans can add a ROTH feature, which allows participants to make after-tax contributions and enjoy tax FREE investment earnings on any growth of their investments subject to certain requirements. This can be a powerful tool for participants that believe their current marginal tax rate is lower now than it will be in the future.
3. RETAINING KEY EMPLOYEES AND EXECUTIVES
What would it cost to replace an executive level employee who contributes significantly to the growth of your organization? Plan sponsors often seek ways to retain key employees and non-qualified deferred compensation plans could be an ideal solution.
Non-Qualified Deferred Compensation Plan: A plan offered to a select group of highly compensated and key employees allowing for the delay of receipt of compensation to a future date. These are available in different forms, but two common approaches are:
- Deferred compensation plans – These plans can assist plan sponsors that may have failed 401(k) discrimination testing and providing highly compensated executives with refunds. It can be structured to mirror the provisions of the 401(k) plan. They can also be structured as supplemental retirement savings plans to allow high income earners to reduce their taxable income or who are behind on retirement savings.
- Executive Bonus or Retention plans – These plans can be used as incentivization tools to reward employees for performance. Discretionary contributions are allowed and are subject to vesting schedules.
Non-qualified plans are often designed with longer vesting schedules to encourage key employees and executives to remain with an organization or risk forfeiting their benefit. This can be a great tool to both reward your mission critical employees and encourage their retention.
4. SAVE FOR YOUR OWN RETIREMENT AS A BUSINESS OWNER AND REDUCE TAXABLE INCOME
In addition to helping participants save for retirement, business owners want to prepare for their retirement as well. Their goal is often to reduce their taxable income and look for ways to increase the amount they can save annually. The IRS sets limits on how much participants can contribute to their 401(k) plan annually, which is $19,500 in 2020. While those limits are strictly enforced, business owners can save more annually by adding additional plans.
- Profit-sharing plan: Contributions can only be made by plan sponsors and are limited to the lesser of 25% of compensation or $57,000 in 2020 ($63,500 if age 50 or older) when combined with a 401(k) plan. They are made on a discretionary basis, but it must have a set formula for the profit allocation. Typically, a company will allocate a percentage of compensation to all employees.
- Cash balance plans: Cash balance plans a considered a “hybrid” plan, possessing the characteristics of both defined contribution plans (e.g. 401k) and defined benefit (e.g. pension plans). Employers make a contribution (percentage of page or flat dollar amount) into participant accounts which then grows by an assumed interest credit. The amount you can contribute varies by age, but it can exceed $275,000 for older participants. Contributions are mandatory so they are best for professionals with substantial and predictable income from year-to-year. These plans do have higher costs than 401(k) plans because of required actuarial certifications, but they can allow older business owners tax advantages that may outweigh the incremental costs.
HOW THE TRUST COMPANY OF TENNESSEE CAN HELP?
As you can see in the above examples, plan design can play an integral role in the success of a retirement plan. However, success is defined by the goal that plan sponsors are trying to achieve. Each year, we assist our plan sponsors reevaluate their goals and can assist them in navigating the myriad of choices to identify the best plan design for their goals.
- Transamerica – 2019 Retirement Survey