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Plan Types

Defined Contribution Plans

• Money Purchase: Money purchase pension plans are a form of defined contribution plan, which means that the contribution amount is defined each year, generally as a percentage of compensation. The retirement benefit derived from the plan is dependent on the investment results achieved during the time of plan participation. The formula for the contribution percentage is defined in the plan document, and the resulting annual deposit to the plan is obligatory, regardless of the profitability of the business. The percentage selected in the plan may range up to 25% of compensation. However, whatever formula is selected must be adhered to when annual contributions are due. A change to the contribution formula requires amendment of the plan.
  
  
• Profit Sharing: Profit sharing plans, like money purchase plans, are a form of defined contribution plan. However, a profit sharing plan may be established with a discretionary contribution formula, which allows the employer to determine the amount deposited according to current business conditions. Allocations of the contribution amount are based on a formula using compensation as a controlling factor. Although this type of program allows complete flexibility in annual contribution amounts, the general level of contribution is lower than a money purchase plan. The total contribution to the plan may not exceed 15% of the annual payroll of eligible employees. (However, through certain flexibility in how contributions are allocated, it is possible for individual employees within the plan to receive more than a 15% allocation of contributions, but not to exceed 25% of pay.)
  
  
• 401(k) Plan: This is a modified type of profit sharing plan which allows the employees to voluntarily contribute, through payroll deduction, an amount of their salary to the plan. These "elective deferrals" are pre-tax monies contributed to the plan, and are not subject to current taxation as compensation. (They are, however, subject to Social Security taxes.) In addition to the elective deferrals, the employer may structure the plan to accept various types of employer contributions to the plan, including matching types of contributions and profit sharing contributions. Although some 401(k) plans are established with funding only from employee elective deferrals, this type of program is generally created to form a funding partnership between employer and employees. It is one of the most popular programs available due to its flexibility, and the fact that funding by employees can relieve the employer of some of the burden of annual contributions, while still providing an employee retirement benefit program of great perceived value. 401(k) plans are subject to stringent anti-discrimination testing, which must be performed each year to ensure that the plan is not operating in a discriminatory manner. The total pre-tax contributions each year may not exceed 15% of eligible payroll.

Hybrid Programs

• Age-Weighted Profit Sharing Plan: Like a normal profit sharing plan, contributions to this program are completely discretionary and need not be made in lean business years. It is also subject to the same maximums as the normal profit sharing plan. The difference with the age-weighted profit sharing plan is that the allocation of plan contributions is not based solely on compensation, but also takes age into consideration when apportioning the monies contributed. Simply stated, it is an approved way to favor older participants. The rules allow for the projection of benefits for purposes of comparing highly compensated participant accruals to those of non-highly compensated participants, and the contributions made to the plan may appear to discriminate in favor of the highly paid as long as the projected benefits do not. This type of program can be very appealing for those employers whose principals are older and more highly compensated than the employees, and who need flexibility in contribution levels.
  
  
• Target Benefit Plan: This type of program is classified as a defined contribution plan, and is subject to the 25% of compensation maximum. However, the plan structure actually projects an annual retirement benefit based on a benefit formula outlined in the plan document. Once this benefit is calculated, an extrapolation is performed to determine the amount of contribution required to fund for that benefit. The formula may be based on compensation, years of service, years of participation in the plan, etc., much the same as a defined benefit plan. But after the projections are done, the resulting contribution becomes subject to the normal defined contribution 25% maximum. Like a money purchase plan, the amount that must be contributed each year is obligatory, and any change to the formula must be done through plan amendment.
  
  
• New Comparability (Cross Tested) Plan: Like the age-weighted profit sharing plan described above, the new comparability plan is a profit sharing plan with all of the inherent contribution flexibility, and subject to the same general limits. This plan also projects benefits for purposes of comparing accrual rates to show non-discrimination. However, the cross-tested plan goes through several additional steps to set up rate groups for comparing benefit accrual rates. Each of the rate groups are then tested separately to determine compliance. This type of program can heavily load contribution allocations for those participants who are somewhat older and more highly paid. However, it is also more expensive to establish and administer than the typical types of programs.