By Randy Neumann
These days, there are many choices when it comes to retirement plans. Do you have the right plan?
Let’s begin with some history. The granddaddy of pension plans is generally considered to be ERISA. It was signed into law, on Labor Day, in 1974. Although it is the first comprehensive pension-plan legislation, there were preceding forays.
President John F. Kennedy created the President’s Committee on Corporate Pension Plans after the Studebaker Corp. closed its plant in 1963 and was unable to pay its retirees. In 1967, Sen. Jacob Javits of New York proposed legislation that would address funding, vesting, reporting and disclosure issues, but the bill was opposed by business groups and labor unions, both of which sought to retain the flexibility they enjoyed under pre-ERISA law.
ERISA was the first federal pension law. Prior to it, employers could move across state lines and stiff their employees by not making pension-plan payments to their retirees. This was similar to bank robbers in the 1930s. Back then, if you robbed a bank in Kansas and drove across the state line to Missouri, you could not be arrested for robbing the bank in Kansas. This changed when the federal Bank Robbery Act of 1934 made it a federal offense, so no matter where you robbed a bank, you could be arrested in any state. Similarly, ERISA federalized the pension laws so employers were responsible to employees in whichever state the employers operated.
There have been many amendments to the ERISA legislation over the years. So, as the ad said, “This is not your father’s Oldsmobile.”
One example is the Uni-K. Using this tool, if you make $100,000, are self-employed and over age 50, you can make a pension contribution of $42,000. This contribution will reduce your taxable income to $58,000 ($100,000 minus $42,000). It puts $42,000 into a trust that will not be taxable until you make a withdrawal; furthermore, you can do this annually.
A more traditional 401(k) works as follows. You can contribute up to $16,500 a year (plus an additional $5,500 if you’re over age 50) on a pre-tax basis. Pre-tax means that if you contribute $16,500 a year, it doesn’t cost you $16,500 because you get an income tax deduction on your contribution. For example, if you are in the 30% tax bracket and you contribute $16,500 to a retirement plan, your out-of-pocket cost is $11,550.
Nowadays, there are several variations of a 401(k) plan. The Safe Harbor 401(k), a byproduct of the Small Business Job Protection Act of 1996, combines the best features of the traditional 401(k) and a SIMPLE IRA, making it very attractive to a business owner. With a Safe Harbor plan, an owner-operator can avoid the big administrative expenses of a traditional 401(k) and enjoy higher contribution limits.
The Safe Harbor plan allows for employers to make matching or non-elective contributions. Employers typically match contributions dollar-for-dollar until the employer’s contribution equals 3% of an employee’s compensation. Past that, an employer may optionally match employee contributions at 50 cents on the dollar until the employer’s contribution equals 5% of the employee’s compensation.
The SIMPLE 401(k) is designed for small business owners who don’t want to deal with retirement plan administration or non-discrimination tests, and it is available to businesses with fewer than 100 employees. Like a Safe Harbor plan, the business owner must make fully vested contributions (a dollar-for-dollar match of up to 3% of an employee’s income, or a non-elective contribution of 2% of each eligible employee’s income). For 2011, the maximum pretax employee contribution to a SIMPLE 401(k) is $11,500, and employees with a SIMPLE 401(k) can’t have another retirement plan with the same company.
The new kid on the block is the Roth 401(k). Imagine a Traditional 401(k) fused with a Roth IRA. Here’s the big difference: you contribute after-tax income to a Roth 401(k) and, when you reach age 59, your withdrawals will be tax-free (provided you’ve had your plan for more than five years). The annual contribution limits are the same as those for a Traditional 401(k) plan.
Another fairly new addition to the retirement plan lineup is the DB(k) plan, which is a defined benefit retirement plan with some of the features of a 401(k). Companies with fewer than 500 employees are starting to implement them. They offer plan participants a retirement savings plan with the potential for a small income stream in the future, mimicking the pensions of years past. The pension income equals either 1% of final average pay times the number of years of service, or 20% of that worker’s average salary during his or her five consecutive highest-earning years.
As my drill sergeant said to his troops at the end of a training session, “Well, there you have it.” The above-mentioned are just a few of the ideas available when setting up a retirement plan. If you are an employer or employee, you might want to revisit what you currently have and compare it to what is now available.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann CFP® is a registered representative with securities and insurance offered through LPL Financial. Member FINRA/SIPC. He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.