Posted by Casey Foulk
Occasionally, a tax client of our firm wants to set up a retirement plan. For a small employer with limited accounting and human resources personnel, the numerous options and complicated jargon can be overwhelming. Although our accounting firm does not provide third party administration or plan document services, we are often the first stop for small businesses who want to set up a new plan, because clients view their CPA as a trusted advisor with an independent and unbiased perspective.
When presented with these opportunities, our first step is often helping the client navigate the basic terminology and understand the key players that will likely take part in their plan administration. To streamline the process in the future, I created the following list as valuable take-away points for retirement plan basics:
Many service providers are involved in plan administration, including:
Third party administrators, custodians, institutional trustees, ERISA attorneys, investment advisors, payroll personnel or a payroll company, human resources personnel, and plan officials who can bind the plan in legal matters on behalf of the plan sponsor, the plan administrator.
Unlike tomato and tomahto, matching and profit sharing contributions are not one in the same. Yes, both are employer contributions made into the plan to benefit plan participants, but these contributions are computed differently. A matching contribution is dependent upon the elective deferral contribution made by the employee. Generally, an employer will match a certain percentage of the employee’s 401(k) or 403(b) deferral. One should consider contributing at least enough to get the full match because who doesn’t like free money, right?
With several waves of restructuring in some local Wilmington companies, many older employees have become self-employed consultants with no employees. Since many of these individuals are approaching retirement age, they are interested in contributing as much as possible to a retirement plan. Specifically, their goal is often to contribute more than the maximum annual addition allowed under a defined contribution plan such as a 401(k)/profit sharing plan. Defined benefit plans guarantee a benefit at retirement, and as such, an actuary computes the required amount of funding needed to achieve the targeted benefit. Unlike a profit sharing plan, funding a defined benefit plan is not an annual discretionary contribution, but a required contribution. The funding requirement is a consideration that attracts some defined benefit plan candidates and dissuades others. For our discussion of the basics, the goal is for the client to understand this is an option that they can pursue further with a document provider and an actuary.
Compensation – Compensation does not automatically equal salary! Compensation could include overtime, vacation, fringe benefits, bonuses, etc. When making elections on the adoption agreement, it is important to define compensation in a way that is not discriminatory and that does not impose unnecessary administrative burdens to a small employer with limited accounting staff.