Redesign Your Retirement Plan in the Wake of Market Losses: Mixing the Good with the Bad
By Randall W. Cook
SAALFELD GRIGGS PC
In today’s volatile stock market, more and more employers are becoming increasingly preoccupied with their retirement plan’s investment returns. Although properly investing your retirement plan assets is certainly fundamental to solid retirement planning, it is sometimes easy to overlook the other fundamental tenet of retirement planning — plan design.
Recent legislative changes to the tax code offer employers greater opportunities than ever before to fund large amounts into their retirement plans. If the design of your retirement plan has not changed in the past few years, it is fairly safe to assume that you are operating under an archaic plan document. Redesigning your plan to increase contributions to your key employees is just as important as examining your investment choices.
Many Profit Sharing Plans allocate employer contributions on a “straight allocation” basis. Under these types of plans, each eligible participant receives a percentage of his or her compensation, which is the same percentage contributed on behalf of other employees. Although these allocation methods are easy to understand and communicate to the employees, they do little to benefit the employer’s key employees.
An alternative to allocating employer contributions on a “straight” basis is to allocate on a “cross-tested” basis. When plan contributions are allocated on a “cross-tested” basis, the employees are first separated into different job classes (e.g., “hourly vs. salaried,” “owners vs. non-owners,” etc.). The employer then has the discretion to allocate different contribution rates to the different classes. In many instances, allocation ratios of up to 4 to 1 are possible.
In addition to re-examining the allocation formula used for profit sharing contributions, many employers are also re-examining the limitations imposed on employee deferrals in their 401(k) plans. In traditional 401(k) plans, the amount of deferrals that can be made to the plan by highly compensated employees (“HCEs”) is linked to the amount of deferrals made by non-highly compensated employees (“NHCEs”). Unfortunately, this means that if an employer has poor 401(k) participation by its rank and file employees, then the key employees will be unable to defer significant amounts into the 401(k) plan.
An alternative to the traditional 401(k) plan is the new “safe harbor” 401(k). Under the safe harbor 401(k), employers commit to making a specific matching contribution or profit sharing contribution, and as a result of that commitment, all HCEs are then permitted to defer the maximum amount into the plan, regardless of the deferral rates of the NHCEs.
Finally, for employers that are interested in making very large contributions to their retirement plans, switching to one of the new “cash balance” plans may be an attractive alternative. A cash balance plan is a defined benefit plan that incorporates many of the attributes of a defined contribution plan. The hybrid quality of Cash Balance Plans allows employers to take advantage of higher contribution amounts, while at the same time mitigating potential disadvantages that can be associated with traditional defined benefit plans. Cash balance plans also tend to be more understandable to participants than traditional defined benefit plans.
One of the services we provide to our clients, at no charge, is retirement plan design analysis. Please contact us if you are interested in receiving such an analysis.