Introduction

Retirement plans offer a number of benefits. A typical plan provides participating employees the opportunity to systematically save for retirement. From the employer's point of view, having a retirement plan can maximize the business's profitability by helping to attract and retain quality employees, and by boosting employee productivity. In addition, in the case of qualified plans and some nonqualified plans, retirement plans can provide significant tax advantages for both employer and employees.

If you are self-employed or involved with a small business (e.g., a partnership or sole proprietorship), establishing a retirement plan can provide benefits for you as well as any employees you may have. As you know, however, small businesses and self-employed individuals have considerations very different from those of large employers. The best retirement plan for a large corporation may not be the best one for a small business with a few employees. Certain types of retirement plans are generally considered more appropriate for small businesses and self-employed individuals.

Caution: If you have employees and wish to establish a retirement plan for your small business, be aware that you will typically be required to cover some (if not all) of your employees under the plan.

Qualified vs. nonqualified plans

As mentioned, qualified retirement plans (like 401(k), profit-sharing, stock bonus, defined benefit, and hybrid plans) offer significant tax advantages to both employers and employees. Employers are generally permitted to deduct their contributions on their federal income tax returns, while participants can benefit from pretax contributions and tax-deferred growth. In return for these tax benefits, a qualified plan must adhere to strict IRC (Internal Revenue Code) and ERISA (Employee Retirement Income Security Act) guidelines regarding participation in the plan, vesting, funding, nondiscrimination, disclosure, and fiduciary matters.

In contrast to qualified plans, nonqualified retirement plans are often not subject to the same set of ERISA and IRC guidelines. As you might expect, this freedom from extensive requirements often provides nonqualified plans with greater flexibility for both employers and employees. In addition, nonqualified plans are often less expensive to establish and maintain than qualified plans. Generally, the main disadvantages of nonqualified plans are (a) they are typically not as beneficial as qualified plans from a tax standpoint, (b) they are generally available only to a select group of employees, and (c) plan assets are not protected in the event of the employer's bankruptcy. For these reasons qualified plans usually appeal to the largest number of employers and employees.

Specific types of retirement plans

The following types of retirement plans are generally considered most appropriate for self-employed individuals and small businesses:

• Payroll deduction IRA plan
  
  A payroll deduction IRA plan is a type of arrangement that you can establish to allow your employees to make payroll deduction contributions to IRAs (traditional or Roth). It can be offered to your employees instead of a more conventional retirement plan (such as a 401(k) plan), or to supplement such a plan. Each of your participating employees establishes and maintains a separate IRA, and elects to have a certain amount deducted from his or her pay on an after-tax basis. That amount is then invested in the participant's designated IRA. Payroll deduction IRAs are generally subject to the same rules that normally apply to IRAs.
   
• SEP plan
  
  A simplified employee pension (SEP) plan is a tax-deferred retirement savings plan that allows contributions to be made to special IRAs, called SEP-IRAs, according to a specific formula. Generally, any employer with one or more employees can establish a SEP plan (although it is best suited for the self-employed, or a sole proprietor or partner with net business income). With this type of plan, you can make tax-deductible employer contributions to SEP-IRAs for yourself and your employees (if any). Except for the ability to accept SEP contributions from employers (allowing more money to be contributed) and certain related rules, SEP-IRAs are virtually identical to traditional IRAs.
   
• SIMPLE IRA plan
  
  A SIMPLE IRA plan is a retirement plan for small businesses (generally those with 100 or fewer employees) and self-employed individuals that is established in the form of employee-owned IRAs. The SIMPLE IRA plan is funded with voluntary employee contributions and mandatory employer contributions. The annual allowable contribution amount is significantly higher than the annual contribution limit for traditional and Roth IRAs. Employer contributions to this type of plan are tax deductible for the employer, and are excluded from the employee's current income.
   
• SIMPLE 401(k) plan
  
  A SIMPLE 401(k) plan is a retirement plan for small businesses (generally those with 100 or fewer employees) and self-employed individuals, including sole proprietorships and partnerships. This type of plan is structured as a 401(k) cash or deferred arrangement (CODA), and was devised in an effort to offer self-employed individuals and small businesses a tax-deferred retirement plan that is similar to the traditional 401(k) plan, but with less complexity and expense. Employer contributions to this type of plan are tax deductible for the employer, and are excluded from the employee's current income.
   
• Keogh plan
  
  A Keogh plan (sometimes referred to as an HR-10 plan) is a qualified retirement plan for self-employed individuals and their employees. Only a sole proprietor or a partnership may establish a Keogh plan; an employee or an individual partner cannot. Keogh plans may be set up as either defined benefit plans or defined contribution plans.

Tip: The 401(k) plan has become increasingly popular for sole proprietors and solely owned corporations. With individual 401(k) plans (which are also known as solo 401(k)s, employer-only 401(k)s, single participant 401(k)s, and mini 401(k)s), the business owner is typically the only participant in the plan. The appeal of individual 401(k) plans dramatically increased as a result of the Economic Growth and Tax Relief Reconciliation Act of 2001, which (a) increased the maximum deductible profit-sharing contribution from 15 percent to 25 percent, and (b) allowed employee 401(k) deferrals to be deducted separately, in addition to the maximum profit-sharing contribution. These changes allow a much larger deductible contribution than was permitted under prior law. As a result, significant dollars can now be contributed, tax deferred, for the benefit of the business owner.
 

If you are involved with a corporation, your business may have multiple employees. One of your goals in choosing a retirement plan may be to balance their needs against the needs of your business. There are many types of plans that may enable you to achieve this goal, including the following:

• Payroll deduction IRA plan
• Simplified employee pension (SEP) plan
• SIMPLE IRA plan
• SIMPLE 401(k) plan
• 401(k) plan
• Profit-sharing plan
• Money purchase pension plan
• Age-weighted profit-sharing plan
• New comparability plan
• Thrift/savings plan
• Defined benefit plan
• Target benefit plan
• Cash balance plan
• Employee stock ownership plan (ESOP)

Overview Executive & Director Benefits 

Our goal is to meet the following corporate and Executive & Director goals:

• Offer a benefit concept that can be constructed to address the specific needs of the executive and board.
• Implement a benefit plan which meets the financial requirement of the corporation.
• Provide implementation and ongoing plan administration that meets the highest standard of service to the executives and directors involved in the plan and the internal administrator.
• Provide a benefit which can be easily communicated and appreciated by executives, directors and their families.
• Maximize benefit security to the extent allowed.
• Provide tax-favored, tailored solutions to the executive’s particular needs.
• Provide systems and communicate plan information and documentation to personal advisors.

Increasingly, corporations are using executive and director benefit programs to attract, reward, and retain key executives and directors.

A selection of our traditional executive and director programs include:

Supplemental Executive Retirement Plans (SERP)

What is a Supplemental Executive Retirement Plan (SERP)?

A Supplemental Executive Retirement Plan (SERP) is a deferred compensation agreement between the company and the key executive whereby the company agrees to provide supplemental retirement income to the executive and his family if certain pre-agreed eligibility and vesting conditions are met by the executive.  The plan is funded by the company out of cash flows, investment funds or cash value life insurance.  Any deferred benefits are not currently taxable to the key executive.  When paid, the benefits become taxable to the executive as income and tax deductible to the company. A typical example of a plan would provide the executive a retirement benefit from all employer-provided retirement benefit plans equal to 70% of the executive’s high three-year average compensation. Another example would be an annual corporate contribution equal to a percentage of base salary that vests over ten years. 

How do Supplemental Executive Retirement Plans Work? 

The company will book an annual expense equal to the present value of the stream of current or future benefit payments. Because of its many advantages, most companies use cash value life insurance to finance the SERP agreement.  The company purchases a life insurance policy on the key employee’s life that is sufficient to recover the cost associated with the future benefits outlined in the agreement.  The company pays the premiums, owns the policy and is the policy beneficiary.  The policy cash values grow tax deferred and can be used at any time by the company at its discretion. 

At retirement, the key executive receives supplemental income, paid by the company, based upon the terms of the agreement.  In the event of the key employee’s death, the policy’s death benefit is payable to the company to recover the cost of the plan and which can also be used to provide continued supplemental benefits or to provide a lump sum benefit to the executive’s named beneficiary. 

Company Advantages with SERPs

Supplemental executive retirement plans using life insurance have several advantages to the company: 

• SERPs are relatively easy to implement and require no IRS approval or involved administration. 
• The company can select the executives it wants to reward with supplemental benefits. 
• The company controls the plan, owns the policy and has book income from policy cash value growth. 
• Cash value within the life insurance policy accumulates tax deferred. 
• When the supplemental income benefits are paid to the key employee, the company gets a tax deduction. 
• The life insurance policy can be structured to allow the company to recover its cost. 

Executive Advantages with SERPs

Supplemental executive retirement plans using life insurance also have several advantages to the key executive: 

• The plan can be custom designed to meet the key employee’s specific needs. 
• Supplemental retirement income can be accumulated without incurring any up front taxes. 
• In the event the executive dies, the life insurance policy death benefits are available to fund the plan and provide a lump sum benefit to the executive’s beneficiary subject to the terms of the agreement. 

Disadvantages of SERPs 

• The company does not get an immediate tax deduction on the premium payments. The deductions come for the business when plan benefits are paid to participant. 
• The cash value build up that accumulates inside the life insurance policy used to fund the SERP is subject to the creditors of the company and is not protected if the company becomes insolvent. 

Deferred Compensation Plans

What is a Deferred Compensation Plan?

A Nonqualified Deferred Compensation Plan (NQDC) is an arrangement whereby an executive or owner defers some portion of their current income until a specified future date. Wages earned in one period are actually paid at a later date. The employer can also make contributions into the plan and apply a vesting schedule to increase the retention aspect of the plan.

Earning on the deferred amounts can be tied to the performance of specific mutual funds, credited at a fix rate of return or tied to an index.

The amounts deferred and earnings will not be taxable to the executive until time of payout. At time of payout the company will receive the compensation deduction for payments made.

The advantages of a nonqualified plan are:

• the employer can pick and choose among the recipient employees without regard to years of service, salary level or any other criteria
• allows a business to provide benefits to officers, executives and other highly paid employees with fully customizable vesting schedules
• the amount of the employer’s contributions are not limited
• there are no significant filing or reporting requirements

Note: There are special timing rules related to FICA taxes and income taxes.

The disadvantages of a qualified plan include:

• the employer is not entitled to tax deductions until such time as the benefits are actually paid to the employee.
• distributions are not eligible for rollover to an IRA or other qualified plan, thereby permitting further tax deferral.
• Account balance are subject to the claims of corporate creditors until time of distribution.

Executive Bonus (162)Plan

What is a 162 Executive Bonus Plan?

An executive bonus plan (Section 162) is a way for business owners or companies to provide additional supplemental benefits to key employees or executives of their choice. The benefits usually include life insurance policy death benefits as well as cash value accumulations that can be used as a retirement income supplement.  With an executive bonus plan, the business can use tax deductible company funds to selectively provide valued benefits to key people.  An executive benefit plan, used effectively, can be a valuable tool to attract and retain key executives. 

Executive bonus plans are simple in design and easy to implement. The executive bonus plan works as follows: 

• The company provides the key executive with a bonus that is taxable as income to the recipient. The bonus is generally a deductible business expense for the company. 
• The bonus is used to purchase a whole life or universal life insurance policy that builds cash value that grows tax deferred. Access to the cash surrender value is restricted by the company until a specific date. 
• The life insurance policy, if properly structured, may provide an attractive benefit to the executive in the form of cash value growth. Any cash value accumulation will grow tax deferred and may be accessed by the employee income tax-free through withdrawals and policy loans. The policy’s cash value can be used to supplement retirement income or for any other financial need. 
• If the key executive dies, in most cases, the heirs will receive the death benefit proceeds from the life insurance policy income tax free. 

Variations of Executive Bonus Plans

In addition to the basic executive bonus plan, there are other common plan variations. These options include a double bonus arrangement and a restricted or controlled executive bonus plan. 

With a double bonus arrangement, the company will provide the key executive with a bonus large enough to pay the life insurance premiums as well as the income taxes incurred by the key executive on the bonus. The company can use the double bonus arrangement to eliminate any out of pocket expense for the key executive. 

If the company wishes to retain some measure of control over the bonus, the controlled executive bonus design is a good choice. With a controlled executive bonus, the company and the key executive enter into an agreement which includes a vesting schedule on the policy’s cash value growth. The vesting schedule is a form of “Golden Handcuffs” that allows a company to limit the availability of the cash value benefits until the executive has fulfilled the terms of the agreement. At that time, the executive is “vested”. Once the key executive is vested, they gain full and complete access to the policy’s cash value. 

Advantages of Executive Bonus Plans

Executive bonus designs using life insurance have several advantages including: 

• An executive bonus plan is simple to implement and easy to administer. 
• The business can selectively choose the key employees they wish to reward. 
• The bonus payments may be considered a fully deductible expense to the company. 
• The key employee is able to name the beneficiary of the entire death benefit of the life insurance policy. 
• In many cases, unless there is a “restricted or controlled executive bonus”, the key executive will have immediate access to policy cash value and may access that cash value without income tax through policy loans and withdrawals. 
• Executive bonus plans are not subject to “qualified plan limits”. 

Disadvantages of Executive Bonuses

There are also some inherent disadvantages in using an executive bonus plans including: 

• The company is unable to fully recover its costs from the policy’s death benefit since the key executive names the policy beneficiary. 
• Executive bonus plans offer the company very little control of the policy. Even if a controlled executive bonus is utilized, it only restricts the key employee’s access to the policy’s cash value. The bonus is never recovered by the company even if the key employee leaves the company prior to vesting. 
• The key executive must include any bonus in his or her taxable income. 
• Without additional planning, the life insurance policy’s death benefit will be includable in the key executive’s taxable estate. 

Director Fee Continuation Plan (DFCP)

What is a Director Fee Continuation Plan?

A supplemental director fee continuation plan is a deferred compensation agreement between the company and the directors whereby the company agrees to provide supplemental retirement income to the director and his family if certain pre-agreed upon eligibility and vesting conditions are met by the director. The plan is funded by the company out of cash flows, investment funds or cash value life insurance.  Any deferred benefits are not currently taxable to the director.  When paid, the benefits become taxable to the director as income and tax deductible to the company. An example of a typical plan would provide the director an annual payment of 50% of highest three year average fees payable for ten years. Payments commence at mandatory retirement age. 

How do Director Fee Continuation Plans Work?

The company will book an annual expense equal to the present value of the stream of future benefit payments. Because of its many advantages, most companies use cash value life insurance to finance the DFCP agreement.  The company purchases a life insurance policy on the director’s life that is sufficient to recover the cost associated with the future benefits outlined in the agreement.  The company pays the premiums, owns the policy and is the policy beneficiary.  The policy cash values grow tax deferred and can be used at any time by the company at its discretion. 

At retirement, the director receives supplemental income, paid by the company, based upon the terms of the agreement.  In the event of the director’s death, the policy’s death benefit is payable to the company to recover the cost of the plan and which can also be used to provide continued supplemental benefits or to provide a lump sum benefit to the executive’s named beneficiary. 

Company Advantages with DFCP

• DFCPs are relatively easy to implement and require no IRS approval or involved administration. 
• The company can select the director it wants to reward with supplemental benefits. 
• When the supplemental income benefits are paid to the director, the company gets a tax deduction. 

Director Advantages with DFCPs

Director Fee Continuation plans using life insurance also have several advantages to the key executive: 

• The plan can be custom designed to meet the director’s specific needs. 
• Supplemental retirement income can be accumulated without incurring any up front taxes. 

Disadvantages of DFCPs

• The deductions come for the business when plan benefits are paid to participant. 

As the name indicates, a tax-exempt organization is not subject to federal income tax. Because of this special treatment, such an organization has unique considerations for setting up a retirement plan. (For example, an employer tax deduction is generally of little or no value.) There are two types of plans that may meet the needs of tax-exempt organizations: 403(b) plans and 457(b) plans.

In addition, tax-exempt organizations may adopt a qualified retirement plan (including 401(k), profit-sharing, money purchase, and defined benefit plans). For more information, including links to detailed discussions of each type of plan, see our separate topic discussion, Retirement Plans for Tax-Exempt Organizations.

Nonqualified deferred compensation plans

You might also consider setting up a nonqualified deferred compensation plan. Compared to qualified plans, these plans are relatively flexible in that they need not satisfy stringent requirements. You and your employees may also receive more benefits under a nonqualified plan, since there are no limits on employer contributions. However, the main disadvantages of nonqualified plans are (a) they are typically not as beneficial from a tax standpoint, (b) they are generally available only to a select group of employees, and (c) the assets are not protected in the event of the employer's bankruptcy. For this reason qualified plans usually appeal to the largest number of employers and employees.

Caution: If you are an owner and wish to be included under the plan, a nonqualified deferred compensation plan will be suitable only if your business is a regular or C corporation.

Stock plans

A stock plan is a form of employee compensation that provides your employees with either stock or an amount of cash that is based on the performance of your company's stock. There are numerous types of stock plans that you can offer to your employee, including employee stock ownership plans (ESOPs), restricted stock plans, stock appreciation rights (SARs), stock option plans, and employee stock purchase plans.