Did you know that by designing your 401(K) plan a certain way, you can increase the amount of deferred income you can invest in your retirement savings plan? Well, I’m going to give you some very interesting information, but before I do that, I want to talk a little bit about our future retirement situation. Our nation is about to lose Social Security and it is imperative today to start thinking about how we are going to finance our retirement without it. Now, most of us know that Social Security was really meant to be a supplement to our retirement and not our primary retirement resource. We also know that many employers offer 401(K) plans for their employees, which help them plan for retirement. The name 401(K) is the section of the Internal Revenue Code where employees can set aside tax-deferred income for retirement. Today, we can invest in our 401(K) plan up to $16,500.00 per year. This amount is based on section 402(g) of the ERISA guidelines, which is the section of the Internal Revenue Code that limits contributions to company pension plans. However, there is an upgrade clause for individual participants over the age of 50 to increase their contributions by adding an additional $5,500.00 on top of their annual contributions of $16,500.00. Sounds pretty generous, huh? Well, there is more…
In addition to ERISA Section 402(g), which is also known as “Defined Contribution,” there is an additional “Profit Sharing” plan that you can add to your company’s Defined Contribution plan. This profit-sharing arrangement allows additional funds to go into a separate account under different rules. Rule 2e bases profit sharing on “pro rata”, where an additional contribution will be set aside for each employee based on their compensation or “integrated” with social security, the formula for this may integrate an employee’s compensation with the social Security. tax base of the security salary. The formula results in a higher percentage allocated to eligible employees earning more than the base taxable wage or a certain percentage thereof. Then you have rule 2a which uses an “age-weighted” formula that takes into account each employee’s age and compensation. The age-weighted formula results in larger contribution allocations to employees who are closer to retirement. In addition, this formula combines the flexibility of a profit sharing plan with the ability of a pension plan to benefit or favor older employees. The second part of 2a is the “new comparability”, also known as “cross-test plans”, where the non-discrimination of the profit-sharing plan is tested as if it were a defined benefit plan that allows certain employees to receive allowances much higher. than normally allowed by standard nondiscrimination tests because an employer can now determine and define certain groups, each of which receives different allowances. The new comparability plans are typically used by small businesses that want to maximize contributions to higher-paid owners and employees while minimizing contributions to all other employees.
As you can see, there’s an incredible opportunity to increase your overall contributions to a retirement savings plan and prepare for a richer retirement. Earlier we discussed the basic defined contribution plan that allows for tax-deferred savings of up to $16,500 or $22,000 if you’re over fifty, then we added a profit-sharing plan to increase overall contribution savings, and now we’re going to dig into a category that is very beneficial for small groups like groups of doctors, groups of lawyers or groups of highly paid executives. By adding a “Defined Benefit” or “Cash Balance” plan to your current 401(K) plan, you can potentially contribute up to a total of $250,000.00 per year on a tax-deferred basis. A “defined benefit” plan is a retirement plan independent of the company, such as a pension plan, in which the employer will set aside a specific amount of money to be allocated to retired employees based on salary history and the amount of years that the employee provided. your employer
So, to summarize, what you as a plan sponsor can provide your highly paid employees is the following in a more quantifiable formula:
Defined Contribution + (up to 3% match) + Profit Sharing + Defined Benefit = Total Retirement Savings per year or Retirement Savings up to $250,000.00 per year.