Question

Discuss the origin and trends in retirement plans in the US. Compare and contrast qualified and non-qualified plans as well as defined benefit versus defined contribution, and hybrid plans.

How can employers leverage retirement plans to their advantage?

How would you leverage a retirement plan within a company you are running?

Answer 1

A retirement plan is a financial arrangement designed to replace employment income upon retirement. These plans may be set up by employers, insurance companies, trade unions, the government, or other institutions. Congress has expressed a desire to encourage responsible retirement planning by granting favorable tax treatment to a wide variety of plans. Federal tax aspects of retirement plans in the United States are based on provisions of the Internal Revenue Code and the plans are regulated by the Department of Labor under the provisions of the Employee Retirement Income Security Act (ERISA)

There are significant differences among retirement plan structures, and these structures determine the considerations employers consider in their approach to offering retirement benefits. A key differentiator among plan types concerns who, whether the plan sponsor or the plan participant, bears the investment risk associated with making investments. A common component of virtually all retirement plan types is that employers will make contributions to employee retirement funds as part of total compensation packages, and frequently employees will contribute a portion of their monthly income as well.

Retirement plans are classified as either defined benefit plans or defined contribution plans, depending on how benefits are determined.

i.Defined benefit (DB) retirement plans guarantee, or “define” the benefits that plan participants can expect to receive upon their retirement. Typically, benefits are calculated according to a formula that takes into account years of employment and salary level, usually providing a percentage of the past three to five years average annual salary to beneficiaries upon retirement. In a DB plan structure, plan sponsors typically invest on their participants’ and beneficiaries’ behalves with the aid of an investment advisor, or they outsource the investment process to a third party. DB structures generally force employers to assume the investment risks for investing on behalf of plan participants, given that the benefits are defined by contractual agreement when employees are hired, regardless of investment performance or market conditions. As these future benefit payouts to retirees represent significant balance sheet liabilities, many employers have closed their DB retirement offerings to new employees in favor of offering defined contribution plans, however these trends differ significantly between regions.

Provides a guaranteed benefit, generally paid in the form of a life annuity, based on a predetermined formula. Generally calculated by age at retirement, years of service, and final compensation. Employer contributions are actuarially determined and may vary annually. May require employee contributions.

ii. Defined contribution plans: Defined contribution (DC) plans guarantee, or “define” the contributions that plan participants can expect employers to make into a retirement account on their behalf. In such a structure, the employer will frequently guarantee to “match” an employee’s annual contribution to their DC account up to a certain percentage of their salary or total dollar amount, thus providing incentive for employees to save. Furthermore, employers, as plan sponsors, will work with investment advisory firms to determine the number and variety of different funds to offer to their employees as investment options within their plan’s “lineup.” DC plan structures therefore offer no guarantees regarding the future benefits that plan participants can expect from their retirement savings, placing the responsibility on plan participants to save and invest their money wisely, while also requiring participants to bear investment risk. In contrast to DB plans, DC plan structures only require employers to account for retirement plan contributions as future balance sheet liabilities, thus reducing the uncertainty and risks employers are exposed to as p

In a defined benefit (or pension) plan, benefits are calculated using a fixed formula that typically factors in final pay and service with an employer, and payments are made from a trust fund specifically dedicated to the plan. Separate accounts for each participant do not exist.

By contrast, in a defined contribution plan, each participant has an account, and the benefit for the participant is dependent upon both the amount of money contributed into the account and the performance of the investments purchased with the funds contributed to the account.

Provides a non-guaranteed benefit based solely on the value of a participant’s individual retirement account. Value of the benefit depends on the value of the individual’s account, including earnings and losses attributable to contributions. Contributions depend upon the plan terms and can include both employer and employee contributions. In some DC plans, employees may make elective deferrals with pretax dollars.

Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution schemes

To guard against tax abuse in the United States, the Internal Revenue Service (IRS) has promulgated rules that require that pension plans be permanent as opposed to a temporary arrangement used to capture tax benefits.

QUALIFIED RETIREMENT PLANS Qualified plans are broad-based employee retirement plans, meaning all employees who meet participation requirements are permitted to join the plan. The term “qualified plan” refers to two plan types: defined contribution and defined benefit. Examples of such plans are 401(k), 403(b), profit-sharing plans, pension plans, individual retirement accounts (IRAs), 457 plans and other retirement plans. The tax advantages of these plans to participants are that: • Contributions are deducted from taxable wages in the year in which they’re made • Accumulated earnings on those contributions are tax deferred • Account balances may be rolled over into a new employer’s plan or to an IRA upon termination of employment Employers may also deduct contributions as wages in the year in which they’re made, and there are no taxable consequences to the employer on plan earnings. Highly compensated employees are most often the senior leaders/executives in the organization. All employees who aren’t determined to be highly compensated (as defined by the IRC) may enjoy the full benefits offered by their plans.

NONQUALIFIED DEFERRED COMPENSATION PLANS Nonqualified plans are for a select group of management and/or highly compensated employees. They don’t qualify for the same favorable tax treatments as qualified plans and are exempt from many IRC and ERISA requirements (including testing) because they aren’t broad-based employee retirement plans. Examples of nonqualified plans are deferred compensation plans, supplemental executive retirement plans, split-dollar arrangements and other similar arrangements.Contributions into a nonqualified plan aren’t deductible as wages by the employer until distribution of the amounts in the participant’s account. Nonqualified plans are established for a number of reasons, such as to help restore retirement parity (due to testing and contribution limits as described above). The plans also provide a means to recruit senior leadership and reward/incentivize strong performance. Though nonqualified plans are not broad-based employee benefit plans, they still must comply with IRC 409A. This is a section of the code that provides guidance regarding the timing of deferrals and distributions. The amounts deferred into these plans aren’t segregated assets as in a qualified plan; instead, they’re held as general assets of the organization. Thus, there’s risk of forfeiture to the highly compensated employee in the event of bankruptcy. This is one of the main reasons a nonqualified plan is not available as a broad-based employee retirement option. Another notable difference is the crediting of interest/earnings to a nonqualified plan. These plans are informally funded, which means that assets aren’t set aside from the general assets and also aren’t within the control of participants.

The term hybrid retirement plan has a wide range of meanings. The U.S. Department of the Treasury, for example, considers most state and local pension plans to be hybrids because both employees and employers contribute to them.Hybrid plan costs are more predictable than those of DB-only plans, because the DB portion of the hybrid plan is smaller and employer contributions for the DC portion are predetermined and do not fluctuate with the market.

Hybrid plans expose employees to greater investment risk than do DB-only plans. Workers’ final accumulated savings in the DC portion are substantially dependent on investment returns that are subject to gains and losses in the financial markets.

A hybrid plan can provide better retirement saving rates than a DB-only plan for early and mid-career workers 4 who change jobs

It includes DB component and a DC component. DB component provides a· guaranteed benefit, generally paid in the form of a life annuity, based on a predetermined formula. DC component provides a non-guaranteed benefit based on the value of a participant’s individual retirement account.

• Employers must effectively communicate the plan can significantly enhance the return on your investment.
• Automatic enrollment, pre-tax and post-tax features, expanded investment options all these offers givesthe employee an enhanced feeling of control. In an environment where so much of their retirement capital is associated with your company plan, peace of mind comes with giving the employees an enhanced say in how their money is handled.
• Now that you have the employee’s attention, use the company retirement plan to promote the other benefits of employment with your company. With communication about the retirement plan, you can also change the conversation from “wages” to “pay plus.” You can promote the company’s contribution to Social Security, the medical plan, flex time and other benefits that enhance the employee’s life.

We can leverage a retirement paln within a company of our own as

• Maximize your earnings

Your needs are more complex than baseline investing options. We custom design retirement plans around you—at a corporate and individual level.

• Invest in your employees

A 401(k) is a sign that you care for the well-being of each of your employees. Giving financial security through a 401(k) will allow you to retain current employees and gain new talent.

• Get your time back

We have automated our daily operations, changing the way 401(k) management is done. From onboarding, eligibility tracking, tax forms, employee communication, payroll processing and more…our goal is to make your job easier, giving you time to focus on more important tasks.

• Save money with “Active Plan Design”

Your company and its needs evolve over time, so why shouldn’t your retirement plan? With our “active plan design” technique, we are continually assessing your plan to find ways to fit your needs more effectively AND save you money.

• Worry less and sleep easy

Don’t worry about compliance, we worry about it for you. We keep up with the constant changes in the retirement industry and ensure your plan is always in good standing. Plus, our included Audit Support Coverage (ASC) has you covered if the situation arises.