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Retirement Plan Design

Retirement plan design establishes the purpose of the retirement plan.  Overall, a retirement plan is an employee benefit that should be considered in the total cost of hiring an employee.  How the program fits into the overall cost of maintaining an employee depends on the company’s benefit structure.  It is easy to look at a 401k plan and see it only as a tax deductible and tax deferred payroll deducted account.  Admittedly those are some of the most attractive features of a 401k. However, there are so many other ways to use a 401k.  A 401k is a type of profit sharing plan.  Before selecting that type of profit sharing plan, there are several factors that need to be taken into consideration.  A retirement plan can be a reward for accomplishing a given level of employment.  It can also be considered a bonus. 

In one retirement plan that I designed, the employer requested that I make gift certificates that would show how much was being put into the employee's account and he could hand them out at the company Christmas party.  It was a tool that worked for that company.  That company did allow employees to contribute their money to the plan. However, they used the profit sharing provision to reward employees for their accomplishments throughout the year.  Their company philosophy was we win together, and we lose together.  So, in lean years, there was little or no profit sharing contribution.   

An individual can establish a profit sharing plan. However, that might not be the best choice.  Profit sharing plans, including 401k’s, do have quite a bit of reporting requirements.  For smaller businesses that want to cut down on administration, choosing a solo 401k, a SEP or a SIMPLE plan would be a better choice.  One of the most significant differences that these plans do not have is employee vesting.  Vesting is the ownership of the employer contributions.  Vesting can last as long as six years, the most common now is three years, 0% ownership in the first year, 40% in the second and after three, 100% of the employer contribution is owned by the employee.   As opposed to the solo 401k, SEP, and SIMPLE plans, the employer contributions are 100% owned by the employee when deposited. 

            A plan that I designed for a small company several years ago may be attractive even today.  The employer was concerned that if a contribution were made for the employees, it would be only a matter of time before the employee was able to use the retirement funds to start a competing business.  To counter this concern, the profit sharing plan had the stipulation that all employer contributions were not available to the employee until the age of 60.  That philosophy worked for that company for years, even as it grew substantially and was eventually bought by a public company.

The design of retirement plans can be very flexible.  Another program that I developed was established by a business that is a division of a much larger European parent company.  European retirement plans are very different than those in the United States.  That subsidiary knew they would have several employees coming from their European parent company.  They wanted the United States plan to be as similar to the parent company as possible.  The design chosen was a 401k option but no matching contribution.  The subsidiary company would make a 10% contribution to the retirement plan regardless of the employees’ level of participation which was similar to the European pension arrangement.  

Additionally, a large medical practice with many doctors established a retirement plan that was uniquely designed for its staff.  All doctors were partners in the practice and shared in the profits of the business; they had several salaried physician’s assistants and many hourly employees including several part-time employees.   This plan did start with a 401k option allowing all employees to contribute their money.  However, there was not a matching contribution.  The employer did make a profit sharing contribution.  In this particular plan, a provision was added that allowed the profit sharing contributions to be divided by level of employment.  The executive class, which was the physicians took a disproportionately larger percentage of the input than the other levels of employees.  The salaried employees had a degree of the profit sharing, the hourly employees another level of the contribution and finally the plan excluded part-time employees from any contributions. 

    Retirement plans that divide the employer contribution by the level of the employee are not as common as a 401k that only matches a specified percentage of employee contributions.  For this reason, the documentation must be drafted specifically for that employer to fit within the parameters of prevailing tax and labor laws.  For this reason, an attorney that is familiar with ERISA law is needed to draft the documents.  ERISA is an acronym that stands for the Employee Retirement Income Security Act of 1974.  ERISA is the governing law that deals with employee benefits such as profit sharing plans.  These plans must also comply with prevailing tax laws.  It is easy to see why a skilled attorney needs to be certain that the documentation of a unique retirement plan is legal.

    Most retirement plans follow a model retirement plan that has options from which to select.  In plans like this, the employer merely picks from options available on a form referred to as a prototype document.  The prototype has been filed for approval with the IRS and cuts down on time and cost of customizing a plan such as that described for the medical practice. 

    It is easy to see that one of the first questions to answer when considering starting or revising a retirement plan is, what do you want the retirement plan to do?  Is it to be considered a part of the compensation to be competitive with other businesses? Is it to serve as a tool for the employer to remove profits from the company on a tax-deductible basis or is it a recruiting tool to attract people from other business and lessen company competition.   With that portion of the planning process completed it is time to move on to how the money in the retirement plan will or will not be invested. (Back)