Wow. The year seems to be flying by, and the annual tax filing is in full swing. This leads me to a topic I am getting a lot of questions about lately: What are the various ways and types of employer contributions that employers are looking at as they try to enhance their retirement plans? Plan sponsors are increasingly looking at benchmarking contribution levels as they search for ways to enhance the benefits they offer their employees.
First, most employers today do some sort of matching contribution to their plans. The amount and level of matching contribution can vary from plan to plan, but one way to enhance the potential that employees contribute to the plan is to look at what matching level it would take to stretch their contribution. Depending on the budget and philosophy of the employer, you can change the level an employer matches to help drive outcomes.
An example would be to increase the match percentage from 25% to 50%. Another example would be to increase the level the employer will match, from up to 4% to up to 6%. Employees tend to increase their contributions up to whatever matching level the employer sets for them in an effort to take full advantage of the employer contributions. This formula is another way to also drive participant outcomes as employers look to help employees save for retirement by helping them get to a higher savings rate in the plan.
Other options
In addition, if employers are really looking for ways to provide additional benefits to employees, they tend to look at profit sharing contributions and formulas. These contributions are unlike matching contributions as they need to be allocated to all eligible employees whether or not the employees contribute to the plan. This is where some strategic planning around plan design can really come in handy for employers.
There are various ways to maximize the profit sharing component today that can create optimal ways to benefit particular groups within the plan. What employers really need to know before they get started with this type of allocation are the details around the demographics of the sub-group they are trying to benefit as well as the group as a whole. The simplest form of a profit sharing allocation is a pay over pay allocation, but this usually does not lead to the best allocation for the owners.
Another type of allocation formula is using Social Security integration. This formula can be done at various levels of integration and is mainly tied to the employees pay level as compared to Social Security. Lastly, a profit sharing allocation type called cross tested has become more mainstream over the last several years as another way to enhance the allocation for different groups based on age and income. This is a formula that works best for groups where the owners are older than their employees and their incomes are higher as well. While the allocation formula is a little more complex, it offers employers who are looking to maximize the benefits for certain sub-groups the opportunity to do so.
Ludwig, ChFC, AIF, CRPS, is an LPL Financial advisor with LHD Retirement. He can be reached at jludwig@lhdretirement.com.
This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
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