401(k)

A 401(k) plan is a type of profit sharing plan, but with a very important difference - the employees contribute their own money to the plan on a pre-tax salary reduction basis. The company's out-of-pocket expense, therefore, notwithstanding matching contributions (if any) and annual administration, is zero. Other types of qualified plans are usually funded with the company's own cash. The allowable salary reduction in a 401(k) plan is generally $19,000 (2019) per participant, for those under 50. Employees over age 50 may defer an extra $6,000 catch up, for a total deferral of $25,000 (2019).

Safe Harbor 401(k)

A Safe Harbor plan is a 401(k) plan under which the employer is no longer required to subject the plan to nondiscrimination testing of elective (employee pretax contributions) or matching contributions. To qualify as a Safe Harbor plan, there are certain employer contribution requirements and 100% vesting of these contributions. The maximum dollar limit for elective contributions ($19,000 for the year 2019) can be contributed by the highly compensated employees, without regard to what the rank and file employees contribute.

Profit Sharing

The Tax Reform Act of 1986 actually made the term "Profit Sharing Plan" a misnomer, as company contributions no longer depend on the profitability of the company. Under a profit sharing plan, the company decides each year what percentage of compensation should be contributed to the plan. This percentage can be anywhere from zero to 25% of total participants' compensation. The contribution is tax deductible by the company. The biggest advantage of a profit sharing plan is its flexibility. The contribution percentage is not a fixed obligation but rather is determined on an annual basis. For example, a company could contribute 15% of compensation for each participant in year one, 3% in year two, no contribution in year three and 25% in year four.

Types of Profit Sharing Plan Allocation Methods

• Salary Ratio Allocation Method
  • Designed to allocate employer contributions to all participants on a straight percentage of compensation basis.
• Integrated with Social Security Allocation Method
  • Designed to give additional allocations to those employees whose compensation is above the Social Security Wage Base (Changes annually with cost-of-living adjustments).
• Age-Weighed Allocation Method*
  • Designed for employers to allocate contributions based on the age and compensation of eligible employees. Age-weighted plans greatly benefit employees who are older and closer to retirement. This could be owners, officers or employees who have been employed for several years.
• New Comparability or Cross-tested Allocation Method*
  • Designed to allow the employer to divide the employees into specific groups and allocate the contribution differently to each group. The employer can give a larger share of the company's contribution to those employees whom the employer wishes to benefit.

*Employer Contributions must satisfy the IRC 401(a)(4) nondiscrimination rules.

Money Purchase

Under a money purchase pension plan, a fixed percentage of compensation is contributed to the plan each year, regardless of profits. The contribution is paid by the company and is deductible by the company. The maximum allowable contribution to a single participant cannot exceed 25% of annual compensation or the annual addition limit in effect for that year. The disadvantage of the money purchase plan is that once the company decides on the percentage contribution, it becomes fixed for subsequent years unless amended. Even if the revenues from the business are down, the employer is still obligated to make the contribution in the required amount. Failure to meet the contribution, or funding requirements will result in an excise tax on the deficiency. With the legislative changes over the years a money purchase plan is not as desirable.

Defined Benefit

Under a defined benefit pension plan, the contributions are actuarially determined based on the anticipated benefit a participant will receive at retirement. In other words, the first step in a defined benefit plan is to determine (define) the ultimate retirement benefit desired. This benefit, expressed in terms of a life annuity, cannot exceed the lesser of $225,000 (2019) per year or 100% of the average high three year compensation (indexed for inflation). Under a defined benefit pension plan, a participant knows from inception what their future retirement benefit will be. It is the company's contribution that in unknown from year to year. The company bears investment risk in that if the assets fail to earn the rate of return that was used in the actuarial assumptions, a greater contribution will be required the following year and possibly further years. Or, conversely, if the investments outperform expectations, the plan will have an actuarial gain which will reduce future contribution requirements. Defined benefit plans favor older participants, since large contributions may be made on their behalf, as they have less time to fund for that benefit. The advantage of a defined benefit plan is that the participant is not limited to 100% of annual compensation or $56,000 (2019) like a defined contribution plan.

403(b) or TSA

A tax-sheltered annuity (TSA) plan, often referred to as a "403(b) Plan" is a retirement plan for employees of public schools and certain tax-exempt organizations. A TSA plan provides retirement benefits by purchasing annuity contracts for its participants.

Simplified Employee Pensions (SEP)

A Simplified Employee Pension plan or SEP is defined as a special type of IRA established by the employer. SEP's allow employers to use IRAs to fund employer-sponsored pension without the complications that typical regular qualified pension plans have.

ESOP and Stock Bonus

An Employee Stock Ownership Plan (ESOP) is a (defined contribution) plan designed to invest primarily in employer stock. To establish an ESOP a company sets up a trust to hold the assets and makes contributions to it of company stock or cash. Each employee participates by receiving a contribution based on his or her earnings. The employee receives a contribution without him or her making any cash outlay, any reduction in pay or losing any other employee benefits.

Cafeteria-Section 125

A cafeteria plan is a welfare benefit plan specifically authorized by Section 125 of the Internal Revenue Code. Generally, employees are given a choice to "redirect" part of their salary. Each employee then uses the "redirected" part of his salary to purchase benefits from a "menu" of nontaxable benefits offered by the plan (hence the term "cafeteria"). The employer may make further contributions to the plan which employees may also use to purchase allowable benefits. Allowable benefits include dependent care programs, uninsured medical expenses not covered by the typical group medical plan, group life, medical and disability premiums otherwise paid by the employee, and contributions to 401(k) plans. Because cafeteria plans allow employees to choose the benefits they want, they are often referred to as flexible spending or flexible benefit plans.