Advanced Plan Design
Many small-business owners may not realize that a properly designed business retirement plan may be their best tax-deferred savings vehicle. Good candidates may have 90% or more of company contributions funding the retirement benefits of the owners.
These designs are not well known because they are based on special age-sensitive testing rules. However, it is important for owners to be presented such in order to be able to make well-informed decisions for their business, their employees and themselves.
These types of designs usually start by splitting participants into categories. In most cases, the categories are “owners” and “everyone else” who is eligible. The objective is to provide the owners with the maximum contribution, in exchange for as little as 5% to the other eligible participants (the minimum depends on plan type and discrimination testing).The two basic options are the following, the choice largely depending on the owner’s maximum contribution objective:
$53,000 with a Tiered 401(k) plan
Each year’s contribution is flexible, but the owner will be capped at the 401(k) maximum ($53,000 in 2015; $59,000 if the owner is age 50 or older).
Up to $200,000 with a Cash Balance or Defined Benefit plan
Each year’s contribution is calculated by an actuary and is required to be made. The maximum contribution, while usually higher than for a 401(k), depends on the owner’s age and compensation (the younger the owner, the lower the maximum).These plan designs tend to benefit successful small-business owners with the following characteristics:
Owner eight-to-ten years older than about half of their employees
The main “head-to-head” test includes one-half or fewer of the Non-Highly Compensated Employee (NHCE)* participants, so not all employees need to be younger than the owner (the remaining NHCE* participants may be aggregated with all such participants into a second test as one averaged group).
Compensation is higher than most of their employees
Testing is also compensation sensitive, so the higher the owner’s compensation, the more likely that the design will result in maximum contributions for the owners and minimum contributions for the others.
Fewer than 10-15 non-targeted participants per targeted owner
Generally, some level of contribution for the non-targeted participants will be necessary. Even if this contribution is limited to the 5% of compensation minimum, the larger the number of non-targeted participants, the lower the percentage to the owner of the total contribution.
A desire to save more on a tax-deferred basis
These designs are for owners who want to save more than about $25,000 per year on a tax-deferred basis. Owners with savings objectives lower than this should consider other plan design options (for example, Safe Harbor 401(k) provisions).