Many companies are experiencing record profits combined with a tight labor market. Offering a company-sponsored retirement plan can reduce income taxes for owners while providing a valuable benefit to employees.
A popular 401(k) option for small and mid-size businesses is a Safe Harbor plan. The deadline for adopting a new Safe Harbor 401(k) for calendar year 2021 is approaching on October 1st.
For those looking to save even more, a 401(k) plan can be paired with a discretionary profit-sharing plan and a defined benefit pension plan.
Why a Safe Harbor 401(k) Plan?
A Safe Harbor plan works like a traditional 401(K) plan in that owners and employees alike can elect to save $19,500 ($26,000 for those 50 and over) per year into their retirement account. Employees can choose pre-tax or after-tax Roth contributions (with no income limitations) and assets in the plan are typically protected from creditors.
In a traditional 401(k), however, owners and highly compensated employees are often limited in their contributions based on the overall participation rate of all eligible employees.
The Safe Harbor provision requires the company to make a minimum contribution or match to eligible participants, but in doing so allows owners and highly compensated employees to max out their deferrals regardless of overall company participation in the plan.
The two commonly used Safe Harbor company contribution options:
• 3% Non-Elective Safe Harbor - Provide a 3% profit sharing contribution to all eligible employees. This 3% can also do "double duty" as it can be counted as an offset for new comparability profit-sharing plans.
• 4% Matching Safe Harbor - Offer non-highly compensated employees a $1 for $1 match up to 4% of income (may increase match to 6% of pay and may include highly compensated).
Safe Harbor contributions are tax-deductible to the company and 100% vested immediately to the participants. Owners have found this trade-off extremely worthwhile. By electing a Safe Harbor, they are allowed the maximum deferral, they too receive a company contribution, and they reward their employees while helping them save for their retirement.
Startup Plan Tax Credit
Employers can now earn up to a maximum $15,000 tax credit spread over 3 years for adopting a plan.
Can I Put Even More Away on a Pre-Tax Basis?
For owners with significant potential profits and thus tax liabilities, a profit-sharing plan can be paired with a 401(k) plan. There are several methods for calculating profit sharing among the pool of eligible employees, but contributions can oftentimes be skewed to owners and select employees. Company profit-sharing contributions are tax-deductible and are not required annually. Adding this option to a plan simply allows for discretionary contributions in high profit/high tax years.
What is a Defined Benefit Pension Plan?
For highly profitable companies with consistent cash flows we have seen great success in implementing a third retirement plan component, a defined benefit pension plan. Defined benefit pension plans often allow for significant pre-tax contributions, sometimes hundreds of thousands of dollars per year.
They work very well in businesses with:
• Few or no employees other than the owners
• Union employees
• Medical groups
• Older owners with younger employees
• Stable and predictable cash flows and profits
There’s still time to consider one or all of these plans for 2021, but the October 1st Safe Harbor deadline is near. Please reach out to discuss which plan, or combination of plans, is right for you.
Happy Planning,
Brian