Key considerations when designing a retirement plan

As of the writing of this column, there are 14  states that have enacted legislation requiring certain employers to offer a retirement savings plan to their employees. These are plans for employers that currently do not offer an employer-sponsored retirement plan to their employees. Generally, the legislation in the states requires employers of five or more employees to offer a plan. These plans are basic and mirror individual retirement accounts with no employer match, no employer discretionary contributions and no flexibility to allocate higher contributions for a select group of employees, such as owners, key employees, etc.

For many business owners today, retirement planning is something they believe is important for both their own and their employees’ financial future. Retirement planning enables individuals to set goals for their retirement income and then develop and implement a plan to help them achieve those goals.

When it comes to the business owner’s own retirement planning, business owners often have several common objectives — and these often inform how they design their retirement plan offerings. These objectives may include asset protection and accumulation as well as estate preservation. Achieving tax savings is also a critical consideration for many.

Because no two business owners are alike, what will work in one employer’s retirement plan offering may not work for another’s. It all comes down to the business owner’s specific goals, objectives and budget.

Two types of qualified plans

Qualified plans are designed to accumulate assets for retirement. The two main types of qualified retirement plans are defined-benefit plans and defined-contribution plans.

A defined-benefit plan promises a specified monthly benefit at retirement. With this type of plan, the company funds and pays its obligations for each of its participating employees.

A defined-contribution plan does not promise a set monthly benefit at retirement. Instead, the employee and/or employer contribute to the employee’s account within the plan. The contributions are invested on the employee’s (i.e., participant’s) behalf, and the participant ultimately receives the balance in the account.

The most common type of defined-contribution plan is the profit-sharing 401(k) plan, which allows an employee to save some of their wages for retirement and have the savings invested while deferring income tax on contributions and earnings until withdrawal. It also allows the employer to make matching and/or discretionary contributions to the employees’ accounts.

In addition to the benefit or cash available at retirement, access to retirement funds is one of the main differences between the two plan types. With a defined-contribution plan, the employee may not have access to their funds until the employee leaves the employer, the employee dies or becomes disabled, the employer terminates the plan, the employee reaches age 59½ or the employee suffers financial hardship. Depending on the plan design, defined-contribution plan participants may be able to borrow money from their account by taking out a plan loan.

With a defined-benefit plan, a participating employee does not typically have access to any plan funds, except to receive retirement benefits at the date specified under the plan. These are most commonly paid out as a lump sum.

How plans are funded

Another primary difference is how these two types of plans are funded: Employers are responsible for funding defined-benefit plans, whereas employees primarily fund defined-contribution plans.

While business owners often use cash flow to finance their retirement plan offerings, a qualified retirement plan may incorporate life insurance on the lives of the plan’s participants to help fund the plan and to provide immediate financial protection. This can be an excellent way for business owners to save money, while protecting their loved ones and assets, using pretax dollars. 

There are many reasons to consider life insurance in a qualified plan, such as:  

» Premiums are tax-deductible inside the tax-exempt trust.

» Life insurance proceeds pass to a beneficiary income-free to the extent they exceed the policy’s cash surrender value.

» Policy proceeds pass estate-tax-free when paid to the spouse.

» The plan is self-completing: If the individual insured under the policy dies before retirement, the life insurance policy will provide all, or substantially all, the monies that would have been available at retirement.

» Asset protection: The assets in an ERISA plan are protected from the claims of judgment creditors. This extends to the life insurance policy.

» Portability: The participant can take the policy with them at retirement.

» In defined-benefit plans, the guaranteed cash value in permanent whole life insurance is used as part of the fixed income portion of the portfolio. This offers the money manager assurance of one portion of the portfolio and the remainder will be adjusted accordingly.

Offering an attractive retirement plan is one way that today’s employers compete for top talent. But because retirement planning is a complex topic, the employer-sponsored plan may be tailored to the specific needs of the employer and the owner(s).  

Ernest J. Guerriero, CLU, ChFC, CEBS, CPCU, CPC, CMS, AIF, RICP, CPFA, national president of the Society of Financial Service Professionals, is the director of qualified plans, business markets for Consolidated Planning. He may be contacted at [email protected].