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Understanding Retirement Plan Sponsorship

11 minute read

How do you determine which retirement plan is best for you? The tax impact of each plan certainly matters. A high-quality tax planning software can help you grow your business and figure out how each plan will affect your taxes. But before taxes even come into play, you need to understand your operational goals and the needs of your employees. With this knowledge, you make the retirement plan selection that is best for you.

Qualified vs. Non-Qualified Plans

Retirement plans can be considered qualified or non-qualified. The Employee Retirement Income Security Act of 1974 (ERISA) governs qualified plans, while non-qualified plans are free of this oversight. Qualified plans are the ones most individuals are familiar with – 401(k)s, 403(b)s, and profit-sharing plans are among the most common – but because non-qualified plans are not governed by ERISA, they can be almost anything that you want them to be.

Qualified Plans

Qualified plans can be either defined benefit plans or defined contribution plans.

Defined benefit plans, more commonly referred to as pension plans, are less common today than they were 50 years ago. They promise a certain benefit to the employee at retirement based on factors such as length of employment and salary. Defined benefit plans are the employer's sole responsibility; the employee plays no part in contributing to their retirement payout.

Estimating investment outcomes decades into the future can be tricky. If employers' estimates are off or they fail to adequately fund their plans, they will find it difficult to pay out pension plans when their employees retire. Although some employers still offer pensions, it is more likely that employers use (or will consider using) a defined contribution plan.

Defined contribution plans make no payout promises. Instead, the employees contribute to their plan throughout their employment. Many employers match a portion of their employees' contributions, but an employer match is not required for a plan to be considered a defined contribution plan.

Most employees contribute to their defined contribution plan with wage deferrals. If employers choose to match a percentage of employee deferrals, they can do so each paycheck or they can make their contributions less frequently – every quarter, or even just once per plan year.

Non-Qualified Plans

Most employers reserve non-qualified plans for employment agreements with key employees and executives because they have greater flexibility to fit the desired outcome. For example, most ERISA-governed plans limit annual contributions and must be made available to all employees. Non-qualified plans have no such requirements and can therefore be used to pad out an executive’s employment package.

Examples of four common non-qualified plans are:

  • Deferred compensation plans,
  • Executive bonus plans,
  • Split-dollar life insurance plans, and
  • Group carve-out plans.

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Plan Sponsorship

To sponsor a retirement plan, employers must set up and maintain the plan document, determine participation eligibility, and ensure the plan is adequately managed. Plan sponsors are considered fiduciaries and remain fully accountable for the plan even if their involvement in investment decisions is contracted to a third party. Although it can be burdensome to sponsor your own plan, you may prefer to do so because it can give you more freedom over your plan types and investment offerings, and you can avoid disagreements with co-sponsors.

For some, sponsoring their own plan is simply too costly. But if you are set on a cheaper retirement plan, you can consider multiple employer plans or pooled employer plans.

Multiple Employer Plans: Explained

Multiple employer plans (MEPs) allow small employers to share the administrative costs of running a retirement plan with other small employers. A closed MEP is co-sponsored by a group of unrelated employers who share a connection or interest with a group or association. Open MEPs do not require a common connection outside of the retirement plan, but the trade-off is that they must file many of their own reports and tax returns. Fortunately, the Setting Every Community Up for Retirement Enhancements (SECURE) Act of 2019 established pooled employer plans (PEPs), a new version of an open MEP that offers even better relief from administrative duties.

Pooled Employer Plans: Explained

PEPs adopt only the best aspects of closed and open MEPs: multiple employers can participate in a single plan for ERISA purposes (requiring only one tax return and one audit), but the employers do not need to be related to one another or share an association. A recent ruling from the Department of Labor paved the way for PEPs to launch in 2021 by explaining how sponsoring organizations can establish a PEP.

Important Parties

Plan maintenance is intricate and tedious work, which is why the IRS has developed a checklist that can help employers keep tabs on the plans they sponsor. It’s also why employers often choose to outsource portions of plan administration and maintenance to third parties. Even if you outsource some of your duties, you will need to coordinate tasks amongst the plan’s custodians, third-party administrators (TPAs), participants, and other fiduciaries.

Fiduciaries

Fiduciaries hold positions of trust. They are responsible for acting in the best interest of the plan’s participants and beneficiaries. The plan sponsor, custodian, and some third party-administrators serve as fiduciaries.

Plan Custodians

Plan custodians are fiduciaries to the plan because they manage the plan’s assets and supervise investment activity. You can act as custodian or appoint a third-party custodian.

Third-Party Administrators (TPA)

TPAs are seldom fiduciaries because they do not control plan assets. Their role is to work with the plan custodian to keep records, answer participants’ questions, coordinate election changes, update beneficiary information, and manage other day-to-day tasks. TPAs work with the plan sponsor to comply with ERISA testing and file tax forms and reports.

Plan Participants

Plan participants are the employees participating in the retirement plan. Participants select investments from the curated list offered by the plan, and they retain both the risk and reward from their investments. When they meet the plan document's qualifications, your former employees may continue to be counted as plan participants and receive the investment growth from their vested contributions – although further contributions are disallowed.

Vesting Schedules

Employees do not immediately own full rights to their retirement plan. While they are always vested in the contributions they make, they are not immediately vested in employer contributions. Employer contributions often follow a vesting schedule where full vesting happens over time – months or years. If an employee terminates before becoming fully vested, the non-vested employer contributions are forfeited.

ERISA Requirements

ERISA-governed plans must abide by certain compliance and reporting requirements.

  • The plan must benefit all eligible employees equitably.
  • The plan cannot discriminate in favor of high earners.
  • The plan must be timely funded.
  • Participant contributions cannot exceed IRS limits.
  • The informational tax return Form 5500 must be timely filed with the IRS.
  • Plans that meet certain participant limits commission an audit.
  • Employees are periodically notified of their account balances and plan changes.

To ensure you are ERISA-compliant, walk through the full list of requirements here.

Tax Consequences

The tax consequences of both qualified and non-qualified plans are complex. Contributions to and distributions from the plan will affect the tax returns of both the employee and employer. We explore the tax consequences in detail here.

Use Tax Planning Software to Select the Right Plan

If you want to sponsor a retirement plan, you will need both money and manpower. Determine your preferred plan(s) by getting a good feel for your or your family's needs. With a quality tax planning software, you see how increasing your employee match will affect your finances. Corvee’s tax planning software is especially helpful when making such difficult decisions because it allows you to test fit different plans and determine which has the best outcome. You are going to be making a significant commitment when adding a retirement plan to your employees’ compensation packages.

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