Pension plan options for cost-conscious companies.
One major benefit undergoing intense scrutiny is the funding of employee retirement plans. The challenge for small companies is to provide employees wit retirement benefits that do not break the company bank. Also, companies that ar not large enough to maintain personnel departments need plans that do not require updated paperwork every few months (or weeks) in order to comply with strict government regulations.
At the same time, companies that want to give their customers high-quality services need to provide high-quality benefits to their employees--before their most valued employees take their talents to a competitor. Employees can afford to give an employer more commitment and loyalty when the company finds a way to give them more financial security. There are a variety of pension-plan options available for managers to consider.
According to Michael L. Rosen, CLU, CHFC (Chartered Life Underwriter, Chartered Financial Consultant), the first step a small company can take toward providing pension benefits is to establish a SEP IRA, or Simplified Employee Pension Individual Retirement Account, for each employee. A SEP IRA merges the employer-provided pension plan with the benefits of an individual IRA.
Under a SEP IRA plan, the employer can make an annual contribution to each employee's retirement account up to the lesser of 15 percent of the employee's salary or $22,500. The employer's contribution is before tax. Once the employer decides how much to contribute to employee SEP IRAs in any given year, that contribution, a percentage of salaries from 0 percent to 15 percent, must be th same for all employees.
In a year with a tight profit margin, the employer might decide to contribute nothing to SEP IRAs; in a great year, the employer might contribute an amount totaling 15 percent of each employee's salary to the plan.
In addition to this high degree of flexibility, SEP IRAs also require a minimal amount of administrative time. SEP IRAs do not entail filing reports with the IRS, so paperwork, according to Rosen, is virtually nil. SEP IRAs work particularly well for companies with 25 or fewer employees.
The money contributed to each employee's retirement grows in a separate, tax-deferred account. The rules that govern any other IRA apply to these accounts: If the employee withdraws any of the money before age 59 1/2, a 10-percent penalty applies, and the IRS treats the money as ordInary in come taxed at the employee's applicable tax rate.
SAR SEP IRAs and combination plans
A variation that employers can offer their workers is a SAR SEP IRA, or Salary Reduction Simplified Employee Pension. A SAR SEP allows employees to make their own before-tax contributions towards retirement. Participating employees agree to have their salaries reduced by a certain amount (or they forego bonuses), an the employer contributes those funds to IRAs instead of putting the funds into paychecks.
To establish a SAR SEP, the company must have had 25 or fewer employees during the prior year, and at least half the company's employees must decide to participate.
The participants may contribute up to the lesser of 15 percent of salary or $9,240 (1994 IRS dollar limitation; the limitation increases slightly each year to account for an inflation factor). Employees who are highly compensated canno defer more than 1.25 times the average deferral percentage for all other employees who are eligible to participate.
A combination of the two plans (SEP and SAR SEP) enables both the employer and employee to contribute before-tax funds towards employee retirement. With the SEP, employers have until April 15 of one year to make contributions for the preceding year. With the SAR SEP, employees must make their contributions by th end of the calendar year to which the contribution applies.
Companies specify the number of times per year their employees can decide how much to contribute to a SAR SEP. In a small company, chances are minimal that a large number of employees will change the amount they contribute to retirement every month, so company policy might allow them to make changes whenever they want.
If employees make changes too often, however, administrative time increases. In this case, the company may designate certain dates (e.g., twice per year) on which employees may decide to change their minds about the amounts they contribute to the plan.
The main disadvantage of these plans, according to Rosen, is that you must follow all the IRS guidelines that govern them, as is the case for any IRS-qualified, before-tax contribution plan. For example, no funds can be distributed to an employee before age 59 1/2 without a penalty. And at age 701/2, the money must be distributed, in amounts determined by an IRS-designed formula.
A 401 (k) plan is very similar to the SEP and SAR SEP plans, except that it involves more paperwork and is generally used by companies with more than 25 employees. This extra administrative cost is the main disadvantage of the plan.
With a 401(k), both employees and employers can contribute monies on a pre-tax basis to employees' retirement accounts in the same manner as with a SAR SEP IRA. The major difference--and added advantage--is that employees have the flexibility of taking out loans and making withdrawals. The IRS penalty for hardship withdrawals is still 10 percent, unless funds are withdrawn for medica expenses, for which there is no penalty. However, there are no additional charges, as there usually are with a SEP IRA.
Note that an additional 20 percent of the deposited amount must be sent directl to the IRS, which holds it until taxes for the withdrawal year have been determined.
Depending on the policy of the company that administers the plan, an employee can usually borrow from the funds earmarked for his or her retirement at very low interest rates. The plan trustee (usually a representative of the employer or company owner) sets a reasonable rate, such as the prime rate plus 2 percent in light of market conditions.
Robert A. Murray, CPM [R], president of RCP Management Company in Princeton, N.J., recently implemented a 401 (k) plan for his employees. The company's work force, including both in-house and on-site employees, numbers about 75 workers. As a first step, Murray decided to contribute 1 percent of employees' salaries to their retirement accounts. Employees can also contribute any amount they wan from their paychecks, up to the 15-percent-of-salary or $9,240 limit.
Almost 95 percent of the company's employees decided to participate. States Murray, "The response was extremely positive. It was an amazing motivational tool." Many of Murray's employees are single mothers or older women who do not have any other pension-plan opportunities. The feedback they gave Murray was that the 401(k) plan offered them security they were otherwise lacking.
A major advantage Murray cites in the 401 (k) is minimal paperwork. He hired th insurance company that invests the money for the plan also to administer it for a minimal charge. The company sends out a statement every month that reports th amount of money put each employee's plan and the income earned. Once a year employees decide how much they want to contribute from their paychecks, and Murray decides on the company contribution.
Funding qualified plans Traditionally, most pension plans were based on defined benefits. Companies made a commitment to each employee to pay a defined, or fixed, amount of money every month of retirement for as long as the employee an his or her spouse lived.
In order to give employees these benefits, corporations use a formula to calculate the amount of money needed for an employee's monthly retirement paycheck according to a set benefit formula based on the employee's average salary and years of service. Corporations may either deposit pension fund monie in a trust account or fund pension payments out of current revenue.
With a defined-benefits plan, companies are not required to make specific, set contributions to the plan in any given year. However, companies are required to pay out the specified amount to the employee: regardless of the financial healt of the company.
Defined-benefit plans require fairly complex paperwork because of the number of employees most plans cover and the complexity of pay-out schedules. In addition an IRS audit program begun in 1989 targeted companies that fraudulently overfunded or underfunded their pension plans to lower their taxable incomes. This resulted in large fines for many companies and for some, re-evaluation of the risks and rewards of providing pension-plan benefits.
Defined-contribution plans represent another benefit option that has gained popularity in recent years, especially with smaller companies that want to provide some sort of retirement benefits to their employees.
Under a defined-contribution plan, the company agrees to contribute a set amoun to each employee's pension fund on a monthly, quarterly, or annual basis. The set amount may be based on a percentage of salary, a fixed sum, or a portion of yearly profits. Upon retirement, employees receive only the amount of money contained in their pension-fund accounts.
Defined-contribution plans are generally funded in two ways. The first is profit-sharing, through which the employer contributes a percentage of salary t employee retirement that can vary from 0 percent to 15 percent, depending on ho much the employer decides to contribute in a given year.
The second is a money-purchase plan. When setting up this plan, the employer decides on a certain percentage of salary, stated in the pension plan filing documents, to contribute annually to every employee's retirement account. Because the employer cannot change this percentage figure without refiling the documents, which costs time and money, the employer needs to have a company wit consistent cash flow in order to make a money-purchase plan a viable option.
Employees may also make contributions to the plan. With a money-purchase plan, the employer can contribute up to 10 percent more of each employee's salary amount to retirement accounts, on top of the 15 percent the employer can contribute with a profit-sharing plan.
According to Robert Click, CPM, of Mathews-Click-Bauman, Inc., Columbus, Ohio, profit sharing has worked extremely well for his company. Every employee who ha worked full-time at the company for more than a year participates in the plan. The company's goal is to contribute 10 percent of salary to each employee's account annually; in years of tighter cash flow, the company contributes 6 percent or 7 percent.
States Click, "The employees are really pleased because they're building a nest egg for retirement. We give them annual statements so they know where their money's invested and how much it has grown.
"So many employees would not be doing that on their own, so it's been a real winner for us. We've had secretaries that have worked with us eight or nine years and left with $25,000 or $30,000 from the plan."
The company's profit-sharing plan, states Click, sets the company apart from it competitors. "The plan allows us to act a little bit like a larger company," he says, "and hire the best employees and give the best service to owners."
Click describes the advantages of the company's benefit package when he markets the company's services to new property owners. Loyalty to the company is high, and even if it costs a bit more to provide the retirement plan, says Click, he would recommend it to anyone.
With a defined-contribution plan, loans and hardship withdrawals are available. Also, most insurance companies and investment brokerage companies offer a choic of investment vehicles in which employees can carry the money. Employees can often dial a 1-800 number to find out how these funds are performing and transfer funds from one account to another on a monthly or quarterly basis.
Paperwork is limited to a yearly IRS filing, and the risk of an IRS audit is much lower than with a defined-benefit plan.
With any of these plans, fully vested employees can roll their pension funds over into personal IRA accounts if they leave the company before retirement.
According to Thom Freismuth, president of Financial Advisory Services based in San Diego, "Qualified plans work well for most employees, but not so well for highly paid, key managers." The reason, he explains, is that the IRS caps on th amount of money that can be put into qualified, pre-tax retirement accounts do not usually allow highly paid employees to meet their retirement-planning goals
In addition to the caps on contributions already discussed, the IRS limits the amount of salary on which a pre-tax retirement contribution percentage can be based to $150,000 for qualified plans.
"If you have an employee who's making $300,000 per year," comments Freismuth, "you can only count half that employee's income toward all the retirement funding calculations." He adds, "Most highly compensated employees know they have to put away more than $4,000 or $5,000 per year to maintain their lifestyles during retirement."
The alternative for highly compensated employees is a non-qualified, deferred-compensation plan. These plans are extremely flexible, and employers can design them to meet their specific needs. An employer may decide to offer participation in a non-deferred compensation plan to some employees, and not to others.
Participating employees decide how much of their salaries to contribute to thei accounts, and the amounts may vary from employee to employee. An employee could even put 100 percent of salary into a non-qualified plan. Plans can be set up s that companies offer matching funds or make set contributions.
The disadvantage to the company is that any contribution to the plan, made typically through salary reduction, is not qualified at the time of the contribution as a tax deduction. States Freismuth, "With a non-qualified compensation plan, the corporation must defer the tax deduction on the amount contributed until the employee takes constructive receipt of the money."
The biggest advantage is the large degree of flexibility employees and the company obtain through these plans. States Freismuth, "As soon as you defer tha tax deduction for the contribution going in, then you can do whatever you want.
The vehicle many companies use to fund non-qualified compensation plans is life insurance. Says Freismuth, "... There's no other product that works better."
The insurance contract can have a fixed guarantee for a minimal growth rate for the cash value of the policy or an annual guarantee that varies with the insurance company's performance. Plans can be set up so that either employees o companies pay the insurance premiums.
A life insurance policy can allow an employee to receive tax-free distributions Freismuth explains that you do this in a way that is similar to refinancing a home: "Say you paid $100,000 for a home that is now worth $200,000. Maybe you could get a loan that is worth $150,000. You do not pay taxes on the $50,000 yo obtain from the re-financing." Similarly, if you have an insurance policy originally worth $100,000, and the funds have grown to $200,000, the owner of the policy can take loans on the policy. The employee pays interest, but not taxes.
Another advantage of non-qualified retirement plans is that there is no minimum retirement age, as there is with IRS-qualified plans, so employees can begin retirement on their own timetables. Also, no reporting or documentation is necessary to meet the requirements of the Employment Retirement Income Security Act of 1974 (ERISA).
A company can require some sort of compensation from participating employees fo the fact that the company forgoes tax deductions on contributions until employees retire.
One life insurance plan that works extremely well for employees seeking to fund retirement is called a flexible premium universal variable life plan. According to Freismuth, these plans "look, feel, taste, and smell like 401(k) plans." An employee who needs to skip premiums can do so. Employees choose from a family o mutual or other funds in which to invest the cash value of their policies.
Not every life insurance agent can sell these policies. Agents must be registered with the Securities and Exchange Commission to offer the product.
Freismuth adds a word of caution to employees who do not also have an ownership stake in the company that offers non-qualified deferred compensation plans: "Th employee has to be comfortable with the corporation's fiscal stability." Even though the company sets up retirement funding through investment-grade insuranc policies, if the corporation goes out of business, employees stand in line with other creditors to obtain their retirement funds.
Pension plans for a company's employees do not have to break the company bank i times of tight profit margins. Defined-contribution plans, especially profit-sharing plans, offer employers enough flexibility to contribute substantial amounts to employee retirement accounts when the company coffers ar full and little or nothing when receivables suffer.
Non-qualified, deferred-compensation plans allow highly paid employees to contribute funds above the caps placed by the IRS on qualified compensation plans. The company funding the plan defers the tax deduction it would normally take on the monies contributed through salary reductions or other means.
Returns on retirement plans for a company, as well as for employees, are great. Financial security for employees brings with it loyalty to the company. Companies with experienced, loyal employees provide their clients with the leve of service that sets them apart from their competitors.
Dorothy Walton is a writer with First Analysis Corporation, Chicago. She was previously a developmental book editor for the Institute of Real Estate Management and has written numerous articles for JPM.
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|Publication:||Journal of Property Management|
|Date:||Sep 1, 1994|
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