Many retirement plans are established as a broad-based employee benefit on the basis of the cheapest administrative cost, without much focus on how the company divides up its total contribution. Advisors who neglect to ask "Who does the employer want to benefit and why?" may not be providing the best service to their clients. Business owners, whose decision whether or not to sponsor a plan may well be driven by personal economic motivations, may not be very happy with a plan design that fails to deliver sufficient benefits to themselves, their family members and other valued employees. Advisors risk losing their clients to other advisors who will take the time to more thoroughly probe plan design objectives.
What are the characteristics of an "ideal" plan design for business owners, their working family members and key executives? It should satisfy owners with different objectives, deal appropriately with the expenses of employees, and maximize contributions for family members who work for the firm. For business owners, the "ideal" plan had the following elements:
Meets Legal Requirements
The challenge in developing the ideal retirement plan is that the law requires that plan design not discriminate in favor of "highly compensated" employees. The definition of a highly compensated employee includes anyone who owns more than 5% of the business, employees receiving more than $95,000 in compensation, and family members of 5% owners. A plan that fails to provide the appropriate level of benefits for "non-highly compensated" employees will violate the non-discrimination rules and will lose its tax qualification. IRS regulations contain an extensive series of objective numerical tests to determine whether a plan is discriminatory. The ideal plan has a design that maximizes plan contributions for owners (and perhaps other key employees) without being viewed as discriminatory under the law.
Makes Economic Sense
Let's say you have a client who owns a business without a retirement plan. At a 40% tax bracket, the owner retains about $.60 of each $1.00 the business earns. If the owner establishes a retirement plan that gives away more than $.40 of every $1.00 contributed for the benefit of non-favored employees, the economic value of the plan to the owner is questionable. Ultimately, a retirement plan needs to produce a result that is economically viable for its sponsor. The objectives for an "owner-focused" retirement plan include: 1) retaining more of the aggregate plan contributions for the owner than otherwise would be kept after taxes in the absence of the plan; 2) maximizing plan contributions for the owner (and other favored employee); and 3) keeping staff contribution costs at the lowest possible level.
Provides Contribution Flexibility
The plan should be able to accommodate changes in employee demographics, normal (and unusual) business cycles and changing tax laws. The ideal retirement plan must also address multi-owner businesses situations, where each owner has different contribution objectives for themselves and their family members who work in the business.
If a business has younger employees, a "new comparability" allocation formula may be recommended. A new comparability design establishes different contribution tiers for favored and non-favored employees, based upon age disparity (with contributions skewed in favor of older employees).
The "Ideal" Retirement Plan Support
When it comes to retirement plan design, one size definitely does not fit all. Yet, when a plan is sold as a commodity, it can result in significant dissatisfaction to the business owner, whose individual needs and circumstances warrant a more personalized approach. Advisors who provide wealth management services should look for retirement plan design and compliance experts who will help them implement the "ideal" retirement plan, which can make a difference of millions of dollars at retirement for their clients. The expert will not only design the plan, but also work closely with the advisor through the sales and implementation process, and then on an annual basis to support the determination of the optimum contribution each year.
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