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  • Writer's pictureJohn Hickey

The basics of defined contribution and defined benefit plans

In this blog, I will be focusing on retirement plan options for business owners and their employees. These plans fall into two categories, defined contribution plans and defined benefit plans.

Defined contribution plans include Self Employed Pension (SEP IRA), Savings Incentive Match for Employees (SIMPLE IRA & SIMPLE 401(k)), 401(k) plans, 403(b) plans, and 457 deferred compensation plans. In a defined contribution plan, the employer, employee, or both make contributions on a regular basis. The money coming out depends on the account performance, and the participant bears the risk.

In a defined benefit plan, the employer or sponsor promises a specific payment to the employee. It is “defined” because the benefit formula is known in advance. Here the risk lies fully on the employer.

Each plan has different funding limits, administrative and filing requirements. Some of the plans are qualified, and subject to ERISA (The Employee Retirement Income Security Act), and some are not. Some use IRAs (Individual Retirement Accounts) as funding vehicles, and others use individual accounts within the plan trust.

As an employer, the first step in looking at a plan is deciding what your goals are. You may want to consider tax savings, building retirement assets, attracting employees, employee retention, and the budget for contributions.

The second step is looking at your employees. Important information includes their ages, length of employment, typical number of hours worked, wages, their interest in participating in a plan, and identifying those that would typically fall into a highly compensated group (5% or greater owners, certain family members of owners and those making over the Social Security wage base of $137,700).

Using this information, we can categorize the plan options to determine which are most likely to help you meet your goals and we can eliminate those that will not. From that list, we then look deeper at the plan features, requirements, and costs to narrow down your options even further. And finally, together we decide upon the best option together, and we put together the numbers for that option for your review.

The final step, once the decision has been made on which plan you’ll be using, is the implementation process. We work closely with you to ensure that all legal requirements are satisfied as well as covering operational activities such as payroll remittances, and informing and educating employees. One way I like to think we are different than other plan vendors is our ability to build relationships with your employees, so that we become their plan resource and this minimizes any impact on the plan sponsor's already busy schedule.

After this final step, we are still there for you offering ongoing support. We have found many of our competitors focus on the sale, then you are passed on to an implementation team, and finally, you are able to seek support through their 800 number. We work hard to ensure that the plan you select is a good fit for your needs and we ensure that we fully explain the full requirements and responsibilities.

If you would like to learn more about the types of retirement plans you can offer your employees, I would be happy to speak with you. You don’t have to be committed to implementing a plan for us to start the discussion. We are here at your service to help educate and advise you.

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