It’s All in the Design…

The economy continues at its strong pace, keeping unemployment at its lowest rate in nearly 50 years. While this is usually good news, employee financial vulnerability is clouding this sunny forecast. The repercussions are impacting their ability to save for retirement.

Millennials are the most stressed by their financial situations, followed by Gen X and Baby Boomers according to PWC’s 8th annual Employee Financial Wellness Survey released in June 2019 (Figure 1 bottom right). More than 80% of the employees surveyed believe they will have to work during retirement.

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 or highly compensated group (HCE)?” Since Social Security limits the amount of compensation that is used to calculate benefits (called the 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.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

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