“One of the biggest challenges in business today is attracting and retaining the best people,” points out Carl Pon, co-managing partner of Vicenti, Lloyd & Stutzman LLP. “A tax sheltered retirement plan can help a great deal with this challenge.”
Smart Business spoke with Pon about tax sheltered retirement plans, the benefits they provide and the importance of keeping employees in the loop.
What type of tax sheltered retirement plans are there?
There are two basic types: defined-benefit plans and defined-contribution plans.
With a defined-benefit plan, retirement benefits are paid to employees based on a formula and the participants receive this set amount for the rest of their lives upon retirement. These types of plans, however, are a vanishing breed. A defined-contribution plan is where employees have individual accounts that grow based on their contributions to the plan.
Tax sheltered retirement plans are also known as qualified retirement plans, which means they qualify for these special tax treatments. In addition, there are nonqualified retirement plans, but these are usually used only for key employees and owners of a business.
How can these plans serve as tax shelters?
They provide three basic types of shelter. First off, they provide a tax deduction for the business, which provides current tax savings. Secondly, the investments inside the plan are sheltered from income tax. Thirdly, the employee is sheltered from any tax on what goes into the plan until they take the money out of the plan.
The business has to legally adopt the plan and communicate it to its employees. Once that is done, the company needs to put money into the retirement plan trust. Then those funds are invested so that they can grow to provide greater benefits.
How can a company benefit from using these types of plans?
Getting and keeping good people is the major benefit. It can also provide significant benefits to the owners of the business. Finally, the assets inside the retirement plan are usually protected from any creditor claims.
One of the challenges is explaining the benefit to the employees so that they can understand and appreciate the value of it. Also, there are some administrative challenges in terms of communicating and continuing to educate the employees on what is going on inside the pension plan. It’s particularly important with 401(k) plans where employees may have to agree to have some money taken out of their own paycheck to go into the pension plan, and where they make their own investment decisions.
Ideally, a company should have a kickoff meeting to explain the benefit to its employees. Then human resources should have a one-on-one meeting with all new employees who join the company. Also, it’s a good idea to have quarterly meetings where your plan’s investment adviser comes in and explains to your employees what has been going on in the investment markets so that they can make good choices in directing their investments.
What steps should a company take to get started with a tax sheltered retirement plan?
The first step would be to talk with your financial advisers about how this would work for your organization in light of all the other compensation packages you have. The plan should fit with the strategic direction of your company, and the exit plan of the owners as well.
Why would a company not want to do this?
There is a measure of fiduciary liability that goes to the managers within the company who are overseeing the operation of the plan. Another concern is that sometimes employees don’t perceive there to be value to the plan. Also, sometimes employees can develop a sense of entitlement the expectation that money will go into the plan regardless of how the business is doing. Finally, there are the administrative challenges. All in all, however, I believe that most of the time the good outweighs the bad in terms of the challenges and benefits that a tax sheltered retirement plan can present.
CARL PON is co-managing partner of Vicenti, Lloyd & Stutzman LLP. Reach him at CPon@VLSLLP.com.