The 401(k) is the most popular and fasting growing retirement plan. This type of plan allows employees to defer a portion of their compensation into the plan on a pre-tax basis (before Federal and, often, State taxes). Contribution amount is based on age. Employers can match contribution rates, but this matching contribution must be vested at the rate of 20 percent annually, beginning after two years of employment. A faster vesting schedule is up to the discretion of the employer. Although no employer contributions are required, many firms match contributions to encourage employee participation. The 401(k) requires adherence to a nondiscrimination test. This test limits the amount highly compensated employees can contribute from their salary to a multiple of the average amount contributed by non-highly compensated employees.

The safe harbor 401(k) plan is a way to avoid this testing. Added in 1996 under the Small Business Job Protection Act, it provides the ability to pass testing by making a 100 percent vested matching contribution to all non-highly compensated employees. This match must meet the amount of the employee’s deferral up to three percent of pay and by half of the next two percent deferral. The safe harbor provision may be used and changed from year-to-year and requires an appropriate and timely notice to employees. A disadvantage of the safe harbor plan is that no allocation requirements can be imposed, and employer contributions must be fully vested.

In a money purchase pension plan, the annual employer contribution level, once defined, becomes a mandatory company obligation unless the plan is amended. Participants can count on a certain level of employer contribution each year; however, this can be constricting for employers for whom profit levels are not steady. For this reason, this is a good plan for well-established companies who have a stable cash flow. Contributions Employer contributions are tax-deductible, and all contributions grow tax-deferred. These plans are easy to establish and maintain. However, they are also subject to discrimination testing.

Defined benefit pension plans provide a pre-defined annual retirement income for employees. Contributions are based on specific income requirements, along with actuarial variables such as years until retirement, life expectancy, compensation, etc. Vesting can vary from being immediate to delay across seven years. Employer contributions are required. Employee contributions can be required or voluntary depending on the plan. This plan provides a predictable benefit level, which employers can plan for. However, these plans are more costly than other plans and are seen as “the most administratively complex plan,” according to the IRS.

Employee stock ownership plans allow for employer contributions of company stock to participating employees. ESOPs can provide capital within the business for expansion or acquisition. This type of plan is beneficial to the employer in that they receive an increased cash flow and tax savings. ESOPs provide a workforce of highly motivated employees who hold a stake in the success of their company.

Profit sharing plans are the most flexible qualified plans available, allowing for deferred sharing of profits among employees. This type of plan is a defined contribution plan. Contributions are usually discretionary, allowing companies to vary deposits from year to year. Because of the flexibility of contributions, this is an ideal plan for businesses where cash flow may be a problem. However, administrative costs can be higher than those of more basic plans. Profit sharing plans need to be tested to prove that benefits do not discriminate against non-highly compensated employees. Earnings on these accounts grow on a tax-deferred basis.

Types of Profit Sharing Plans include Age Weighted, Integrated and Tiered. Another type of Profit Sharing Plan is the New Comparability Plan, which maximizes contributions to owners and highly compensated employees while minimizing those for other employees. This method allows the employer to divide the employees into specific groups with each group receiving a different contribution rate.

An age-weighted profit sharing plan combines features of defined benefit pension and profit sharing plans, allowing greater contribution levels for employees closest to retirement. These plans have no minimum or required contribution level, but limit the employer's maximum annual. These plans are most beneficial for older employees because they require only a small contribution to younger employees in favor of higher contributions to older employees. Because of compounding interest, the smaller contribution made on behalf of the younger employee will eventually equal that of the older employee.

Tiered profit sharing plans, or new comparability plans, establish two or more groups (“tiers”) of employees based on various criteria. Contribution rates may be different for each tier of participants. This type of plan works best for small companies (roughly 30 employees or less) in which the owner is older than most plan participants and key employees' salaries are the most highly compensated. Nondiscrimination testing for new comparability plans is very sensitive to demographic changes. In a small business, the plan may fail the test when a young non-highly compensated employee is replaced by a much older employee.

CHOOSING A PLAN