Safe Harbor 401k with Age-Weighted Profit Sharing: A Win-Win for Businesses

Safe Harbor 401k with Age-Weighted Profit Sharing: A Win-Win for Businesses

For many small businesses comprised of one or several highly compensated employees and a few non-highly compensated employees, the Safe Harbor 401k plan may be the best option if maximizing contributions is a primary objective. Safe harbor plans effectively remove the barriers of discrimination testing that limits the amount that can be contributed for highly compensated employees. However, what if the objective is to be able to contribute the maximum amount allowable under the tax code? That’s where a combination safe harbor/profit sharing plan can be the ultimate solution for maximizing the retirement savings opportunities for business owners and their highly compensated employees.

How Does a Safe Harbor-Profit Sharing Plan Work?

A Safe Harbor 401k plan is a 401k plan alternative for smaller businesses that seeks to weigh their contributions more heavily to the owners and/or highly compensated employees. Essentially, the plan requires a prescribed employer contribution be made on behalf of all employees and they must be 100 percent vested. With that, employers can skirt the testing for contributions required of regular 401k plans – otherwise referred to as a “safe harbor.”

These plans are well-suited for smaller businesses with less than a half dozen employees which are weighted more towards the highly compensated. While it’s a significant step towards increasing their contribution capacity, it still leaves a significant amount on the table.

Adding an Age-Based Profit Sharing Plan

An age-based profit sharing plan is generally compared to a defined benefit plan that allows discretionary contributions. Factors such as age, retirement timeline, and length of employment are considered as part of the formula for allocating contributions. So, in businesses where the owners or key employees are significantly older than the other employees, it can favor the former while not being discriminatory against the latter. That’s because the contribution amount is based on projected benefits an employee can expect to receive at retirement. The closer an employee is to retirement, the higher proportion of employer contributions he or she can expect to receive.

In a simple example, an owner and his wife, both 48, earning $250,000 and $100,000 respectively could increase their total contributions substantially by combining a Safe Harbor 401k plan with an age-based profit sharing plan.

Under a normal plan rules, the owner and his wife could contribute up to $18,000 and receive a 4 percent employer match bringing their total contributions to $27,800 and $22,000 respectively.

By adding a profit sharing component, they could receive an additional contribution up to his 415 limit of $53,000 (2015 limit) and his wife’s total to $35,877. In doing so; however, they would have to include eligible employees in the profit sharing contribution.

Based on profit sharing calculations, they would have to make a contribution of approximately 7 percent on behalf of their three employees earning $41,000, $36,000 and $32,000.  Based on a total payroll of $109,000, the 4 percent match made under the 401k plan would amount to just under $4,400. The additional 7 percent profit sharing calculation would add $7,630, bringing their total exposure to just over $12,000. However, this additional investment will enable the business owner and his wife to increase their contributions by more than $40,000. The additional tax savings realized by the business partially offsets the increased investment.

In the right situation, the Safe Harbor 401k – Profit Sharing arrangement is a win-win for the business and its employees. And, because profit-sharing contributions are not mandated, businesses enjoy the flexibility to adjust their contribution strategy according to its changing circumstances. Although it does require plan design, administration and reporting, the benefits to the business, key employees and employees invariably outweigh the costs.

 

What Is the Definition of a Highly Compensated Employee?

What Is the Definition of a Highly Compensated Employee?

Determining if you have highly compensated employees (HCEs) isn’t hard.  The Internal Revenue Service (IRS) is clear on who qualifies as an HCE.  An HCE is an individual who:

  • Owned more than 5% interest in the business during the current or preceding tax year.
  • Received more than $125,000 in compensation or is in the top 20% of employees ranked by compensation.

What can be more difficult is how those HCEs impact your business’ 401(k) retirement plan.  A little history is needed to understand the impact.

 401K History

Did you ever wonder where the 401(k) concept came from?  The Revenue Act of 1978 laid the groundwork for 401k retirement plans.  The Act was designed to provide equal opportunities for employees to save for retirement.  With no cap on the annual amount an employee could save, it became apparent that there was inequity in the initial concept.  Enter the annual nondiscrimination test for all companies offering a 401K plan.

Nondiscrimination Test

The nondiscrimination test divides employees into two groups:  the highly compensated and the non-highly compensated (NHCE).  The tests look at the contributions of the two groups to make sure that the plan is not masquerading as a  tax-deferred plan for HCEs. The IRS wants to ensure that NHCEs have access to a comparable retirement plan.  As a result, they examine the contributions to determine if they are proportionate across all groups. Failure to comply comes with significant consequences to HCEs.

 Failing the Test

The IRS gives a company 12 months from the year of infraction to correct any problems with a 401(k) plan.  In most cases, the company can increase the amount it contributes to NHCEs, or it can return some of the contributions to the HCEs.  These contributions are then taxable. 

To find a 401(k) plan for your small business that will pass the annual nondiscrimination test, contact us, or request a proposal.

Have You Considered a Simple or Payroll Deduction IRA?

Have You Considered a Simple or Payroll Deduction IRA?

Small business owners may think that a 401(k) retirement plan is too complex to implement and too costly to maintain.  But offering a retirement plan is crucial to attracting and retaining employees. Nearly 51% of employees joined their current company because of the retirement plan.  Before you decide whether or not to offer a 401(k) consider these three steps to setting up a 401(k) for your small business.

Set Your 401(k) Goals

As a business owner, be clear on why you are setting up a 401(k) small business retirement plan.  Each objective might require a different plan. The three reasons a small business offers a 401(k) plan are:

  • To maximize savings for business owners
  • To provide tax savings
  • To attract and retain employees

Tax credits are also available for small businesses, but be sure your plan is designed to take advantage of them.

Find a 401(k) Advisor

Finding a qualified advisor may take a little time.  You can ask for a referral from your accounting firm or another small business owner. Your Chamber of Commerce or local Score office may have a list of advisors. Regardless of whom you select, be sure to choose a credentialed advisor.  Good 401(k) advisors should offer services that:

  • Build and monitor your plan
  • Provide guidance on legal-related issues
  • Ensure proper allocation of funds
  • Act as a financial advisor to you and your employees
  • Benchmark your plan to match your business growth

Some advisors may offer administrative services as well.  When looking for an advisor, be sure your advisor can provide the services you need now and into the future.

Decide on a Provider

Designing a retirement plan means deciding on the specific features and corresponding rules for your plan.  The plan’s design should match the goals you set at the beginning of the process. Part of setting up the plan is finding the right provider for your 401(k) investment funds.  That’s why it is crucial to find the right 401(k) advisor who can help you design and implement a qualified retirement plan.  Contact us for more information.

3 Steps to a 401K for Your Small Business

3 Steps to a 401K for Your Small Business

Small business owners may think that a 401(k) retirement plan is too complex to implement and too costly to maintain.  But offering a retirement plan is crucial to attracting and retaining employees. Nearly 51% of employees joined their current company because of the retirement plan.  Before you decide whether or not to offer a 401(k) consider these three steps to setting up a 401(k) for your small business.

Set Your 401(k) Goals

As a business owner, be clear on why you are setting up a 401(k) small business retirement plan.  Each objective might require a different plan. The three reasons a small business offers a 401(k) plan are:

  • To maximize savings for business owners
  • To provide tax savings
  • To attract and retain employees

Tax credits are also available for small businesses, but be sure your plan is designed to take advantage of them.

Find a 401(k) Advisor

Finding a qualified advisor may take a little time.  You can ask for a referral from your accounting firm or another small business owner. Your Chamber of Commerce or local Score office may have a list of advisors. Regardless of whom you select, be sure to choose a credentialed advisor.  Good 401(k) advisors should offer services that:

  • Build and monitor your plan
  • Provide guidance on legal-related issues
  • Ensure proper allocation of funds
  • Act as a financial advisor to you and your employees
  • Benchmark your plan to match your business growth

Some advisors may offer administrative services as well.  When looking for an advisor, be sure your advisor can provide the services you need now and into the future.

Decide on a Provider

Designing a retirement plan means deciding on the specific features and corresponding rules for your plan.  The plan’s design should match the goals you set at the beginning of the process. Part of setting up the plan is finding the right provider for your 401(k) investment funds.  That’s why it is crucial to find the right 401(k) advisor who can help you design and implement a qualified retirement plan.  Contact us for more information.

Why Your Start-Up Needs a 401K Plan

Why Your Start-Up Needs a 401K Plan

Most business startups are focused on selling their products or services.  That’s understandable.  If you’re not selling, you’re not generating revenue, and without reliable cash flow, your company struggles to survive.   But not too long after launching a business, you’re looking at hiring your first employees.  You want to make sure you get the right employees from the beginning.  Employee turnover is a costly proposition, especially for a fledgling business. It is estimated that it costs 2.5 times a person’s salary to replace a lost employee. That’s as much as $75,000 for an employee making $30,000 per year. 

Attracting Employees

According to Willis Towers Watson, 51% of employees joined their current company because it offered a retirement plan.  Offering a 401k retirement plan shows candidates you care about their financial well-being.  Meaningful benefits such as a small business 401k plan lend credibility to your company, which is crucial for a startup.

Retaining Employees

Many business owners think they can’t afford a 401k retirement plan but companies that offer this benefit report increased employee retention and happier, more efficient workers.  With a tight labor market, offering a 401(k) plan for small business is essential to retaining employees.

Saving on Taxes

In 2001, a tax credit was created to encourage more business to launch retirement plans.  The tax credit is for costs associated with starting a retirement plan, including a 401(k).  The credit equals 50% of the first $1,000 of qualified startup costs, including expenses to set up and administer the plan. That does not include the long-term savings that come from investing pre-tax dollars in a retirement plan for you and your employees.

Setting up and administering a 401k is as simple as Requesting a Proposal.   We can help position your business to attract and retain employees through a small business 401k retirement plan.