Defining your plan

The call comes into Parker/Hunter Inc.’s office fairly regularly — a business owner tells the investment firm that his company needs a 401(k) retirement plan.

Indeed, 401(k) plans have become the retirement savings vehicle of choice for lots of businesses, and for some good reasons. They’re relatively easy to establish, they don’t saddle businesses with promises that will become difficult or impossible to meet in the future and employers can contribute matching amounts at their discretion.

But while 401(k)s offer lots of attractive features for employers and employees alike, some company owners find they aren’t the best option, says Bob Bishop, a senior vice president at Parker/Hunter who helps companies and business owners design retirement plans. The call for a 401(k) comes, in many instances, because it is the plan that is most familiar, but it’s not necessarily a one-size-fits-all solution.

Retirement plans are divided into two general categories. Defined benefit plans offer a specific benefit to the employee, calculated, for the most part, by the worker’s length of service at retirement.

Defined contribution plans, including 401(k)’s, accumulate funds in an individual worker’s account through their own and, in some cases, the employer’s contributions. At some point, employees can begin to withdraw from their account, based on their needs and the funds available in it.

Defined benefit plans, because of the liability that employers must bear in covering payments to retirees — they have to be funded to meet that obligation and it can be very costly to do so — have been abandoned by many businesses in favor of less-expensive defined contribution plans.

Even if a company falls on hard times, it is required to fund its defined benefit plan to meet the actuarial forecast of its future obligation. A business with an older work force that has long average tenure will have a bigger burden in funding its plan, especially if it has a bad year financially.

Defined contribution plans, on the other hand, allow the employer some flexibility in determining its matching contribution.

Ironically, while defined benefit plans have fallen out of favor with employers, Bishop says they can be an excellent solution for business owners and professionals, including physicians, dentists, accountants and lawyers with a relatively short time before they plan to retire and a need to accumulate substantial retirement assets.

The 401(k) plan, for instance, limits combined employer/employee contributions to $40,000 a year. But a defined benefit plan for a business owner generally allows contributions that will fund a benefit that does not exceed the lesser of $160,000 or 100 percent of average compensation over the employee’s three highest paid consecutive years.

There are some catches, however. A defined benefit plan requires the services of an actuary to calculate the contributions required to meet the funding needs of the plan. And some companies may not be able to establish such a plan because of certain nondiscrimination rules.

Companies with 100 or fewer employees might want to consider the Savings Incentive Match Plan for Employees, or SIMPLE IRA, a design that permits employees to make pre-tax contributions through salary reduction and allow up to $8,000 of their yearly compensation ($9,000 if an employee is 50 or older).

Employers must contribute 2 percent for all eligible employees or match contributions up to 3 percent of an employee’s compensation. A Simplified Employee Pension, or SEP, is inexpensive to administer and allows an employee to make discretionary contributions for employees.

In any case, advises Bishop, business owners shouldn’t establish a plan that is more complex than their needs require.

Says Bishop: “I think it’s always best to start with the simplest structure that meets your needs.” How to reach: Parker/Hunter,