|Business Planning, Benefits & Strategies
- Harnessing the Power of 401(k) Plans
401(k) Plans - An Overview
In the past decade, no retirement plan has become more popular with large and small companies than the 401(k).
A 401(k) plan is a retirement savings plan offered by a corporation to its employees. The plan allows eligible employees1 known as plan participants, to contribute a portion of their annual income2 to an account in their own name. Contributions reduce each participant's taxable income, and all earnings potentially grow tax-deferred until withdrawn.3
Some employers who offer 401(k) programs make matching contributions. A "matching" contribution is when an employer contributes a portion of each eligible participants' deferral amount to a separate account based on a pre-determined formula.
Employers can also combine a 401(k) plan with a profit-sharing plan. In a profit-sharing plan, all eligible employees receive a profit-sharing contribution from the employer, regardless of whether they contribute to the program. Some plans may require participants to contribute at some minimum level in order to qualify.
Profit-sharing contributions generally range from 0%-15% of an employee's salary. Employers can determine the percentage based on a number of factors, including the amount they would like to contribute or other employees are deferring, fees for plan maintenance, and the costs of employee funding.
1Usually those who have at least one year of service and work more than 1000 hours annually.
2Subject to applicable limits.
3Withdrawal of earnings are taxed as ordinary income and may also be subject to a 10% federal income tax penalty if taken before age 59¨ö.
Major Benefits of a 401(k) Plan to Corporations
Which Companies Are Eligible to Establish 401(k) Plans?
- Helps attract worthy candidates for employment
- Helps retain valuable employees
- Is cost-effective compared to other qualified plans
- Has relatively modest set up and maintenance costs
- Allows corporations to deduct contributions made on their employees' behalf (including profit sharing, employee deferrals and matching contributions)
Major Benefits of a 401(k) Plan to Employees
- Is a relatively easy and painless way to build wealth for retirement
- Allows eligible employees to reduce their current income tax liability
- Enables employees to watch all earnings that have the potential to grow tax-deferred until withdrawn
Companies can establish a 401(k) plan regardless of their particular business structure. Recent law changes have even made it possible for many non-profit organizations to establish 401(k) plans. Companies can also establish 401(k) plans, regardless of the number of employees that they have.
Remember, the amount that certain highly compensated employees can contribute to a 401(k) plan generally depends on the amount contributed by other employees.
The more all employees participate in a 401(k), the better it is for highly compensated employees. But business owners should not be discouraged from establishing a 401(k) if they believe participation will be low. They can often use the profit-sharing option to increase their own contribution to the plan.
- Strategies for Executive Benefits
Executive Benefits Plans - An Overview
All corporations interested in the long-term success of their business should know the importance of Executive Benefits Plans. These plans help corporations:
- Recruit key managers
- Retain key employees
- Reward select employees for outstanding performance
- Improve employee morale
- Give executives additional incentive to grow the business
- Concentrate on developing business-building strategies
Additional Advantages Of Executive Benefits Plans
Executive Business Plans also offer corporations other advantages, such as:
A Sense of Control
A company may choose the participants, plan design and the amount of corporate and/or executive contributions.
Potential Exemption from IRS Approval and Minimal ERISA Requirements
Since Executive Benefits Plans are generally unfunded and structured exclusively for key executives, they may not have to comply with most ERISA requirements nor seek Internal Revenue approval.
No Contribution Limits or Discrimination Requirements
Contributions to these plans are generally unlimited, providing preferential treatment to select executives.
Low Set-Up and Administration Costs
Most Executive Benefits Plans can be relatively easy to establish and maintain. No annual reporting is required, and bookkeeping is usually simple. Moreover, vesting can be nonexistent, or by company's desired schedule.
Generally, all contributions, company matches and earnings are taxed to the executive at the time of distribution.
Major Advantages Of Executive Benefits Plans To Employees
Senior-level managers find Executive Benefits Plans attractive for many reasons:
- Executive Benefits Plans provide benefits that go beyond traditional raises or bonuses.
- These plans can help executives save money on taxes today and build wealth for the future through potential tax-deferred growth of earnings.
- In most cases, Executive Benefits Plans are not subject to contribution limits.
- These plans offer executives tremendous flexibility in securing their financial futures.
Business Continuation and Succession Planning
This type of planning is vital to help ensure that your business survives in the event of a life cycle change, i.e. death, disability, or retirement. This can mean keeping the family business in the family or, in the case of non-family businesses, helping to ensure the orderly transfer of business interests.
Specifically, we provide the following resources for guidance on the various planning strategies and funding techniques, specifically geared to the desired goals of the company. These goals can include succession planning, the selling of a business or key executive benefit plans. Potential strategies and services include:
Cross Purchase Buy-Sell
Information and strategies on ways to set up and fund a business succession agreement between key executives within the company.
Information and strategies on ways to set up and fund a business succession agreement through a trust.
Wait and See Buy-Sell
Information and strategies on ways to set up and fund a business succession agreement when it is unclear who the successors are.
Strategies and techniques for funding a plan to redeem the stock of a shareholder upon retirement, death or disability.
Today, 65%-70% of companies with over 5,000 employees have a supplemental benefits plan for their senior-level executives, compared to 55%-60% just five years ago.1 Executive benefits plans are very popular with large companies. More than 81% of the Fortune 1000 companies already have such a plan in place.2
In 1990, 7,000 employers offered non-qualified plans, while in 1997 that number had increased to 25,000, according to the May/June 1999 issue of Profit Sharing magazine, a publication of the Profit Sharing/401(k) Council of America.
Main Benefit Of Executive Benefits Plans
The main reason for the popularity of executive benefits plans is that they don't discriminate against highly compensated executives. In fact, these plans allow a corporation to provide valuable benefits designed specifically for the highly compensated team.
Executive benefits plans help executives deal with lost opportunities created by governmental regulation and limitations of qualified plans, including 401(k) plans, pension plans and profit-sharing plans.
1Buck Consulting, 1999 Compensation Survey.
1KPMG Peat Marwick L.L.P. Supplemental Retirement Plan Survey, 1996.
Types of Executive Benefits Plans
There are many different types of executive benefits plans. Below is a brief description of each one and its main benefits:
Supplemental Executive Retirement Plans (SERP) mirror or supplement a specific retirement plan.
- Employee contributions are usually not required.
- Employees pay no federal income taxes on the benefits until they are received.
Deferral Plans allow for pre-tax contributions which "mirror" 401(k) contributions lost under non-discrimination limitation rules. Contributions can, and often do, substantially exceed these lost contributions. The company can establish the contribution limit at any level that it desires.
- Employees reduce their current income tax liability.
- Any contributions and earnings grow tax-deferred.
- Employer can make matching contributions to replace lost contributions.
Executive Bonus Plans enable select executives to own cash value life insurance.
- Tax-deferred accumulation.
- Death benefit is income tax-free to personally named beneficiary of the executive.
- Executive controls the life insurance policy.
Cost-Sharing Plans (Split Dollar Life Insurance Plans) whereby the company and executive share the cost and benefits of a cash value life insurance policy.
- Executive can receive permanent life insurance coverage.
- Executive can receive cash value accumulation.
Deferral Plans Can Kick in Where 401(k)s Leave off
With an executive benefits plan, companies can make sizable contributions on the behalf of their employees each year. A traditional retirement plan, however, has annual contribution limits, which greatly limit the amount that a highly compensated executive can invest annually.
The following hypothetical example illustrates this premise. It shows how a highly compensated executive who participates in a 401(k) plan could, because of these contribution limits, be missing substantial deferral opportunities, plus the opportunity for matching contributions from his or her employer.
Assume two employees -- one a supervisor, the other a senior executive -- at the same company have annual earnings of $40,000 and $200,000, respectively. Both are contributing the maximum to their 401(k) plan. For 2000, the contribution limit is $10,500 or 15 percent of annual income, whichever is less.
Based on contribution limits, the supervisor can contribute 15 percent of his or her annual income to the plan given that 15 percent of $40,000 is less than the maximum limit. Because 15 percent of his or her annual income exceeds the contribution limit, the executive can only defer a little more than 5 percent.*
*Additional limitations are present, which may limit the amount available for deferral to even a greater degree.
Furthermore, because of the limitation on contributions, the senior executive could also lose matching contributions.
In all, the lost deferral opportunity would equal 10.5 percent annually. Or to look at it another way, the senior executive would lose the opportunity to defer more than $20,000 in income annually.
What would that mean in dollars and cents over many years? If you assume a hypothetical 8 percent annual return, the senior executive would lose the opportunity to accumulate $1,658,043 over 25 years.*
1Index is adjusted for inflation through 1/1/2000.
2Reduced percentage due to testing.
* Does not represent the return from one particular product. Does not take into account the effect of taxes or any applicable investment fees.
Securing and Funding SERPs and Deferral Plans
Rabbi Trusts allow specific assets to be segregated by the company to pay plan benefits to the participants. The trust assets, treated as company assets, remain on the company's balance sheet and are subject to the claims of the company's creditors. Thus, if the employer becomes insolvent or bankrupt, the employees under the non-qualified retirement plan will be unsecured general creditors of the employer. Additionally, any taxable income generated by the trust is considered taxable income of the company. Assets in the Rabbi Trust may only be used to pay plan benefits or to pay creditors in the case of insolvency or bankruptcy.
Companies may adopt various informal funding techniques to pay for plan liabilities and still maintain an unfunded status.
Corporate Owned Life Insurance (COLI) is the most common funding method. With COLI, a company buys life insurance policies on the lives of the executives and names itself as the beneficiary.
The company cannot deduct the premiums as a business expense. It can, however, list the policy's cash value as an asset on the balance sheet, and simultaneously provide current retirement benefits. Additionally, the potential tax-deferred growth of the cash value may help offset plan liabilities and produce a positive earnings impact.
With life insurance as a funding vehicle, a company may be able to recover all the costs of establishing and maintaining its supplemental benefits plan.
WNLLC Offers Expertise in Executive Benefits Plan Design and Administration
Setting up and administering a supplemental benefits plan requires a knowledgeable staff of trained professionals and state-of-the-art technology. WNLLC has the resources, knowledge and experience to provide for plan administration needs in a cost-effective and timely manner. They offer a wide range of solutions and services for companies interested in establishing executive benefits plans. These include:
Plan Administration Services
- As-Sold Illustrations
- Plan Participant Statements (Benefit tracking statements)*
- Benefit and Plan Accounting Reports*
- Communication, Documentation
- Setting up Rabbi Trusts
- Setting up Secular Trusts
Policy Administration Services***
- Benefit Payment Processing
Executive Compensation Planning
- Deferrals, SERPS
- Cost-Sharing & Bonus Plans
Analysis of funding alternatives to reduce corporate and executive costs
Specific expertise in COLI product design to address benefit liabilities