As executives grow older, many of them want to put more money away than the limits of traditional plans — 401(k) and 403(b) plans, for example. They want to catch up and accelerate their savings before retirement. Several types of retirement plans are designed to not only help executives save more, but also defer their current income, and thus lower their current tax liability.
Because these plans are attractive to executives, they’re a recruitment and retention tool. Some plans can be designed to provide performance incentives with the reward of greater savings and deferred income. The company may also benefit from a tax deduction, depending on the plan.
“There’s more interest in these plans as the economy improves and the job market tightens up,” says Jeff Spencer, CPA, MAcc, tax principal at Ciuni & Panichi.
Smart Business spoke with Spencer about how company leaders can design retirement plans that fit their needs and provide great benefits for their executives.
What retirement plans benefit executives?
There are plans beyond the traditional 401(k) or 403(b) plans. Different allocation structures will compensate your executives, so you can attract and retain them. In fact, retirement plans for executives are common enough in larger organizations that not offering them can be a competitive disadvantage. Three common types are cash balance pension, nonqualified deferred compensation and 457(b) plans.
How do cash balance pension plans work?
Cash balance pension plans have recently gained popularity. These plans have an individual account balance, which makes them a hybrid between a traditional pension plan and a 401(k) plan. They’re geared toward older, high-paid executives who want to make large annual contributions and already maxed out their 401(k) plan limits. Depending on their age, pay, the company demographics, etc., the cash balance plan uses a formula — and the services of an actuary — to determine how much they can put away on a pre-tax basis. It could be $200,000 a year, for example.
These plans are typically utilized by smaller companies that are doing well, because once the plan is set up, the annual contribution is generally locked in. It can be very beneficial for professional service companies, law firms, consulting firms, doctor groups, etc., with a few key people who are nearing retirement. The company receives a corporate tax deduction, as well.
Cash balance pension plans also require an offset benefit that needs to be provided to some rank-and-file employees to make it work from a nondiscrimination standpoint. In a law firm, for example, the offset benefit might go to administrative staff who are lower paid and have higher turnover.
What are the benefits of nonqualified deferred compensation and 457(b) plans?
Nonqualified deferred compensation plans are best for larger employers. They’re often utilized by public companies, which want to benefit their top people who are already maxed out on their traditional retirement plan limit.
Nonqualified plans are very flexible. The company can earmark them for key people and design the plan to incentivize people to perform a particular way or create golden handcuffs to keep them around. These plans also can be designed to attract executives.
On the nonprofit side, one option is 457(b) plans. Nonprofits use them to reward, attract or retain top executives who max out their 403(b) plans. The executive pay in the nonprofit arena is typically lower, so midsize and large nonprofits sweeten the pot by adding something like 457(b) plans.
What are common challenges when designing these plans?
The cash balance pension plan is the most complex; the other two aren’t as involved to set up. But the most important thing is to ask, ‘Why are you doing this?’ Are you trying to reward people you already have? Are you trying or attract new people? What’s your end game? You don’t want to put in something that’s not going to fit your organization two or three years later — and have to go through this all again.
There are new and innovative ways to reward people, which is especially critical in today’s tighter labor market. So, if you haven’t looked at your plans in recent years, now is a good time to do so.
Insights Accounting is brought to you by Ciuni & Panichi, Inc.