Magazine article The CPA Journal

Retirement Plans Offer Benefits for Business Owners

Magazine article The CPA Journal

Retirement Plans Offer Benefits for Business Owners

Article excerpt

Higher Contributions and Greater Flexibility

The Pension Protection Act of 2006 (PPA) made permanent the pension provisions of the Economic Growth Tax Relief Reconciliation Act of 2001 (EGTRRA), including higher dollar limits, an increase in the combined deduction limits brought about by eliminating Internal Revenue Code (IRQ section 404(a)(7), and new rules for cash-balance pension plans.

The current dollar limits are as follows:

* The employer deduction limit for individual allocations applicable to profitsharing plans is $51,000 (as indexed for 2013), or $56,500 for individuals over age 50, inclusive of 401 (k) catch-up deferrals; the annual deductible contribution limit is 25% of participating payroll.

* The maximum annual 401(k) deferral limit for individuals is $17,500 (as indexed for 2013).

* Plan participants who are older than 50 are eligible for catch-up contributions up to $5,500 (as indexed for 2013) if the plan permits 401 (k) deferrals.

* The maximum compensation limit used to calculate contributions or benefits for defined contribution plans and defined benefit plans is $255,000 (as indexed for 2013).

* The defined benefit maximum limit is $205,000 (as indexed for 2013) for a benefit payment based on a single-life annuity with a retirement age of 62. This limit may be reduced if the participant has less than 10 years of participation.

Furthermore, 401(k) deferrals do not count towards the 25% annual addition limits. This can lower the profit-sharing formula and reduce the employee cost to owners.

Safe Harbor 401 (k) Plans

If employee deferrals do not sufficiently satisfy the required actual deferral percentage (ADP) or actual contribution percentage (ACP) tests, it might force the return of excess deferrals; this, in turn, could result in taxable income to business owners or highly compensated employees. Safe harbor contributions allow business owners and highly compensated employees to defer the maximum permissible amount- $17,000 (as indexed for 2012)regardless of what other employees contribute, thus eliminating ADP/ACP testing.

This can be done in one of two ways. Under the first option, all eligible employees will receive a 3% nonelective contribution, regardless of whether they defer any part of their salary into the 401(k) plan. Under the second option, the employer can match 100% of an employee's deferrals up to 3% and can match 50% of the next 2% of employee deferrals. This, in effect, will cost the employer 4% of compensation, but only for those participants who defer more man 5% of their pay; if no eligible employees defer, then no employer contribution is required. Thus, the 4% safe harbor maximum matching contribution might be a preferable option when overall employee participation is low. Note that all safe harbor contributions are 100% vested at all times.

Contributions to Owners and Key Employees

One effective design for allocating a larger percentage of contributions to owners and key employees in a profit-sharing plan is to utilize a "new comparability" or "crosstesting" allocation formula. Depending upon the demographics of the business, the results might exceed those of plans using a permitted disparity design (also known as Social Security integration). Since the passage of PPA and the relaxation of IRC section 404(a)(7), companies are allowed to fully fund both a defined benefit plan and a profit-sharing plan if the business is subject to Pension Benefit Guaranty Corporation (PBGC) premiums.

Companies not subject to PBGC premiums are owner-only and owner-andspouse companies that have no other employees, as well as professional services corporations that have fewer than 25 employees. These companies are allowed to have both a defined benefit plan and a profit-sharing plan with 401 (k) deferral, but the employer's profit-sharing contribution is limited to 6% of participating payroll. By funding both a profit-sharing and defined benefit plan, business owners have the ability to make larger tax-deductible contributions. …

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