Retirement Planning

Small businesses that establish 401(k)s must be careful to avoid liability for losses employees might suffer due to fluctuations in the value of plan investments. Under ERISA, plan sponsors can avoid liability by ensuring that their 401(k) meets three criteria: offering a broad range of investment options to employees; communicating sufficient financial information to employees; and allowing employees to exercise independent control over their accounts.

Nonqualified Deferred Compensation Plans

Finally, there is a type of plan often used by businesses to supplement existing qualified plans and provide an extra benefit to key personnel and highly compensated employees. In small businesses, this usually includes the owner and founder. Broadly defined, a nonqualified deferred compensation plan (NDCP) is a contractual agreement in which a participant agrees to be paid in a future year for services rendered this year.

There are two broad categories of nonqualified deferred compensation plans: elective and non-elective. In an elective NDCP an employee chooses to receive less current salary and bonus compensation than he or she would otherwise receive postponing the receipt of that compensation until a future tax year. Non-elective NDCPs are plans in which the employer funds the benefit and does not reduce current compensation in order to fund future payments. Such plans are, in essence, post-termination salary continuation plans. The argument behind such non-elective plans, funded by employers, is the retention of key employees.

One feature in particular of nonqualified deferred compensation plans that has made them a very popular tool for use by large corporations and some small businesses, is the fact that they are not limited by the same non-discrimination rules imposed on qualified plans. NDCPs may be offered to a select group of employees only, unlike qualified plans to which all employees are eligible by definition. Consequently, the cost of this benefit is lower since it accrues to fewer people. NDCPs are a type of plan that is particularly useful for small business owners in augmenting their own retirement savings plans.

WHICH PLAN TO CHOOSE

Small business owners must carefully examine their priorities when selecting a retirement plan for themselves and their employees. If the main priority is to minimize administrative costs, a SEP plan may be the best choice. If it is important to have the flexibility of discretionary contributions, a profit sharing plan might be the answer. A money purchase plan would enable a small business owner to maximize contributions, but it would require an assurance of stable income, since contributions are mandatory. If the small business counts upon key older employees, an age-based profit sharing plan or a defined-benefit plan would help reward and retain them. Conversely, an employer with a long time horizon until retirement would probably do best with a defined-contribution plan. Finally, a small business owner who wants employees to be able to fund part of their own retirement should select a SIMPLE or a 401(k) plan. There are also many possibilities for combination plans that might provide a closer fit with a small business's goals. Free information on retirement plans is available through the Department of Labor at 800-998-7542, or on the Internet at http://www.dol.gov/ebsa/savingmatters.html.