With all the good intentions of their competing legislation to fix 401(k) plans, neither the White House nor Congress fully understand the real problem facing employees about their retirement plans.
And, for all the commotion of the lost value from too much worthless stock held in the Enron and other large company plans, many small employers may still put off sponsoring any plan for their own employees.
This is unfortunate because the changes effective January 2002 under the Economic Growth and Tax Relief Reconciliation Act of 2001 give small businesses and their owners so much more flexibility and opportunity to fulfill their retirement needs, as well as those of their employees. And, the contributions made to these plans are mostly made in cash, not employer stock.
The challenge is to explain these important new advantages without being sidetracked by the medias "bad press" and the restrictive legislation that is being proposed to fix a problem that doesnt exist in the small plan situation. So, here it goes.
First, the new rules permit a profit-sharing plan to have a full employer tax deduction up to 25% of the pay of all participants. Second, the dollar contribution can be as high as $40,000 (up to 100% of salary). The old maximum of 25% no longer applies.
Another change is 401(k) plans that permit voluntary employee salary deferrals (defined as profit-sharing plans) will no longer count these deferral amounts against the employer deduction.
The 2002 maximum dollar 401(k) salary deferral is $11,000 and an extra $1,000 "catch-up" is available to any employee age 50 or older, with both of these amounts increasing by $1,000 each year through 2006.
By providing for a "safe harbor" 401(k) plan design, maximum deferrals can be achieved for an owner even if employees elect not to make any deferrals. However, the plan gets even better for all when the employer agrees to set aside a full "non-elective" 5% of pay whether they defer or not.
So, using the above summary of the 2002 EGTRRA changes, how can we design a retirement program that will be attractive to a small business owner and his family as well as rewarding employees– but at not too great a cost to the company?
As an example, I will use the census of employees in Exhibit 1. (See this page.)
We have two owners–Pat and Tracy. Pat is paid a salary of $80,000 and Tracy is paid $40,000.
There are 10 other eligible employees paid in amounts as shown in Exhibit 1 for a total employee payroll of $300,000. Under the old rules for a traditional profit-sharing plan, the employer would be restricted to a maximum deduction of 15% of total payroll–$63,000 (15% x $420,000). And each employee, including Pat and Tracy, would receive a uniform allocation of 15% of their respective salaries.
Pat would receive $12,000 and Tracy $6,000. All the other employees would share in the overall remaining contribution amount of $45,000. The owners percentage share results in less than 30% of the deduction.
