Before establishing any type of retirement plan for employees, it is essential you consult with legal counsel and a certified financial planner. You must ensure thorough and proper application of the complex federal rules and regulations.
With that in mind, following are some actions to take to successfully establish a retirement plan:
- Become educated about the types of plans available.
- Research related federal law and the Internal Revenue Code.
- Implement the plan with a financial planner and legal counsel.
- Teach employees about the plan and options for participation.
- Encourage employees to contribute the legal maximum amount.
- Match or make contributions to the plan for employees.
- Ensure that relative tax laws have not changed.
There are several types of retirement plans an employer can choose. Among the most common are pension and 401(k).
A traditional pension plan provides a defined benefit in the form of a promised compensation for life, once a participant retires. The benefit of a pension plan typically depends on the recipient's age, earnings, and years of service.
According to IRS Notice 2002-4, 401(k) plans are tax-qualified under the Internal Revenue Code, Section 401. Benefits accrue in an ERISA-protected trust through credits to individual accounts in the name of each participant.
Types of contributions an employer can permit include:
- 401(k) contributions employees usually make through salary-reduction elections, thereby deferring income tax up to the maximum amount allowed by the IRS.
- After-tax contributions employees can also make on a voluntary basis through salary-reduction elections (earnings are tax-deferred).
- Contributions that match all or part of an employee's 401(k) after-tax contributions according to a formula an employer can determine on a discretionary basis.
- Profit-sharing contributions an employer can make either according to a fixed formula or on a discretionary basis at year's-end.
Whether contributions are made by the employer or employee, the deduction limit for total annual plan contributions is 15 percent of covered compensation on an aggregate basis for all plan participants (this limit is lower than the 25 percent limit for money purchase pension plans). ERISA's quarterly funding requirements are not applicable.
In-service withdrawals and plan loans are allowed, but 401(k) deferrals are not permitted to be distributed during one's period of employment, unless an employee demonstrates a hardship. When terminating employment, the 401(k) participant usually has the right to decide between taking a lump sum or installment distribution.