Every forward-looking U.S. worker hopes to set side funds to plan for retirement. However, finding extra cash to save may be difficult for the average worker, especially those employed in small businesses where working capital is not as plentiful. Additionally, small business owners ae often not able or willing to provide assistance with employees' retirement savings. To assist employees in their retirement saving efforts, as well as encourage employers to adopt retirement plans, the U.S. Internal Revenue Code provides a variety of tax-advantageous vehicles through which employees may save funds for retirement. In addition, employers can offer retirement plans for employees that, if they meet certain qualifications under the Tax Code, create tax advantages for both parties. However, with any qualified retirement savings plan for which the government affords tax breaks, there are complex requirements under the tax code and the Employee Retirement Income Security Act of 1997 (ERISA), for maintaining the plans.
Types of Benefit Plans: Three general areas relate to employee benefit plans for retirement
1. Employee Welfare Benefit plans: These are not directly relevant because the plans do not provide immediate retirement benefits to employees; rather they provide other important benefits such as severance pay, supplemental unemployment benefits, health insurance, life and disability insurance, paid vacation and other fringe benefits. Welfare benefit plans assist employees indirectly in accumulating funds for retirement by helping employees to avoid draining retirement savings because of more immediate cash needs caused by unemployment, healthcare costs, etc.
2. Employer compensation and payroll practices: Employers can simply increase employee salaries and advise employees to contribute the extra cash to their savings accounts. Although increasing salaries in the hope employees will save the extra compensation may be the easiest way for employers to help with retirement, this technique does not make use of the tax advantages for qualified retirement plans offered by the Code, nor does it impress upon the employees its value as an 'additional employee benefit.'
3. Retirement Plans: These fall under two categories, 'qualified' and 'nonqualified' plans.
A nonqualified plan is generally a retirement plan that fails to meet the requirements of Code Section 401(a) for qualified plans. Even a nonqualified plan can provide benefits such as the deferral of income tax recognition on contributions, under certain circumstances, which provides employees the benefit of time-value of money savings. Nonqualified plans that meet the requirements under Code Sec. 409A are most often used to provide deferred compensation arrangements to corporate executives and key employees. These plans are not heavily regulated, require little administration, allow unlimited contributions and have tax advantages that are slight compared to those of qualified plans. Under the code, income tax is deferred on the compensation paid into the plan, but only if there is a 'substantial risk' that the employee may forfeit his or her rights to the funds or if the plan meets certain requirements regarding distributions, acceleration of benefits, elections, etc.
A qualified retirement plan is the most tax-advantageous type of plan for businesses. These plans are more heavily regulated than nonqualified plans and have many requirements. For example, plan assets must be held in a qualified trust or custodial account and employers must offer benefits under qualified plans on a nondiscriminatory basis (with respect to salary level) to all rank-and-file employees, not only to highly paid executives and other key employees. Plans are also required to contain 'antialienation' provisions that state that the plan benefits cannot be assigned or alienated. The combination of tax advantages, plus variety and flexibility of plan types makes qualified retirement plans preferable for a majority of small businesses.