A tight labor market requires careful attention to employee benefits. Employer-sponsored pension plans form the basis of these packages. Retirement plans include pensions, 401(k)s, stock bonus plans, and many others. Plan designs are different, but they all serve similar purposes. Retirement plans attract and retain top talent. A suitable plan also meets the organization’s financial goals.
Preparing for retirement has always been important. Increasing life expectancy and rising healthcare costs now make this a necessity. The data reveal the full extent of both trends. Mortality tables show that today’s 65-year-olds have a 50% chance of living to 90. Moreover, they have about a 20% chance of living to be 100 years old. Jumps in life expectancy are due in part to advances in healthcare. Medical interventions defeat deadly diseases and life-sustaining treatments keep our patients alive longer. However, these innovations come at a cost. Experts estimate that the average retired couple may incur nearly $315,000 in health care costs. Longer and more expensive retirement periods require significant savings.
Pension costs are widely recognized. Thus, many workers accept and even expect employer-sponsored retirement plans. The study ranks retirement plans as the top three priorities for future employees. Moreover, three-quarters of workers say they would change jobs for better financial benefits. Businesses are responding to these concerns. In 2020, about two-thirds of private sector workers had access to employer-provided plans, and most took full advantage. Broad engagement leads to a more satisfied, engaged and productive workforce.
Employer-sponsored plans provide clear personnel benefits. They also facilitate the organization’s financial goals. Some plans favor older business owners, while other plans are better suited for early-stage entrepreneurs. Contribution preferences are also important, as some plans have higher contribution limits than others. There are many recruiting strategies.
Business characteristics also drive plan selection. The enterprise’s business model, staff composition and responsibility preferences are key. Organizations with fixed incomes can choose plans that require annual contributions. Conversely, businesses with variable profits may prefer more flexible options. Businesses with high turnover may have stricter compliance requirements than businesses with a fixed workforce. Finally, the complexity of the plan varies greatly. Some organizations are better equipped to handle administrative burdens and liability issues than others.
The options may be vast, but the food is simple. There is a plan for every job. Businesses must choose wisely.
Any benefit discussion requires a basic understanding of plan types. Pension plans fall into three broad categories: defined benefit plans, defined benefit plans, and non-qualified plans. Each type is suitable for certain purposes and conditions.
Most are familiar with defined contribution plans. These include standard 401(k) plans in which the employee makes a certain contribution each pay period. Savings can be pre-tax or post-tax. Some 401(k)s also offer employer matching contributions or year-end profit sharing. Employees make investment choices and market returns determine future account balances. Other defined contribution plans include Money-Purchase Plans, Target Benefit Plans, and Stock Bonus Plans.
Defined benefit plans guarantee stable retirement benefits to employees. Sponsoring companies fund large reserve accounts to support this pledge. Defined benefit plans, also known as retirement plans, have fallen out of favor in recent decades.
The third category is non-qualified plans. These plans are best characterized as simple and flexible. Nonqualified plans avoid federal eligibility, eligibility, and contribution requirements. However, employers usually lose certain tax advantages in return. Non-qualified plans are sometimes called “Top Hat Plans.” They are useful tools for attracting top talent and retaining key executives.
Plan options continue to expand with changing laws and benefits. The table below shows the breadth of retirement plan options. The details, advantages and pitfalls of the plan will be discussed in future articles.
The retirement landscape has changed considerably in recent decades. While previous generations received a guaranteed pension, today’s workers bear a great deal of responsibility for funding their own retirement. This reflects decades of evolution in retirement plan design. Nowadays, traditional pension plans are used only in limited circumstances.
Pensions extend guarantees in an uncertain world. The plan structure requires frequent, predetermined payments to retirees regardless of market performance. This creates a huge investment risk for the employer, as pension fund returns are neither predictable nor guaranteed. Decades of low interest rates and stock market volatility have left many pension plans underfunded.
Pension designs have inherent risks for employers, and changes in society have exacerbated them. Longer life expectancy increased the duration of each recipient’s retirement benefits. Persistent inflation introduced an additional variable. Few plans offered cost-of-living adjustments, and many pensions failed to keep up with rising costs in the 1960s and 1970s. Congress finally tried to restore confidence in the pension system.
Today’s retirement landscape can largely be traced back to the Employee Retirement Income Security Act of 1974 (ERISA). While Congress has long flirted with pension reform, the collapse of several prominent pension funds has forced meaningful action. Among other provisions, ERISA guaranteed pension payments for distressed plans and set minimum participation standards. The bill also charged the Department of Labor with overseeing plans and enforcing ERISA requirements. Pension plans became more transparent, accountable and secure almost overnight.
The 1970s gave birth to a less publicized but equally effective innovation: the 401(k). Before ERISA, some companies allowed employees to transfer their earnings to a retirement account on a pre-tax basis. These accounts, called cash or deferred adjustments (CODAs), have attracted both employer intrigue and regulatory scrutiny. Growing interest finally forced Congress and the IRS to act. The Revenue Act of 1978 included a provision formally allowing employees to defer pre-tax income. The IRS immediately codified the provision as Section 401(k) in the Internal Revenue Code. Suddenly, a cheaper, less restrictive and more flexible option was available to employers.
This seemingly small provision spurred change. Business owners today enjoy an ever-expanding menu of retirement plan options. Employers can choose between pensions, conditional 401(k)s, and hybrids between the two. Other alternatives, such as Stock Bonus Plans and ESOPs, allow employees to have ownership in the sponsoring business. Simplified retirement plans such as the SIMPLE IRA and SEP IRA are available to organizations seeking simplicity. Finally, a number of non-qualified plans avoid burdensome regulations and benefit principals.
Retirement plans serve both employees and owners. For employees, these plans are vehicles that help ensure a comfortable future. Employer-sponsored plans for owners meet staffing goals, business goals and personal ambitions. Unfortunately, choosing a plan can be difficult.
Our business planning experience shows that no two businesses are alike. This is not surprising given the sheer volume of companies across the country. More than 5 million new businesses open in the United States every year. Each of these businesses has a unique passion, vision and management philosophy behind it. Choosing a plan requires a thorough consideration of business conditions and priorities. Individualized instruction supports specific goals.
While businesses vary, one common theme prevails. Business owners are desperate for more time—a resource that is as limited as it is valuable. Daily tasks consume a significant portion of any owner’s week. Administrative responsibilities leave little time for strategic planning. As a result, many institutions have inadequate pension plans or no plans at all.
Professional guidance is invaluable. An experienced team can determine the right plan for each organization. This leaves owners more time to do what they do best: lead, create and grow.
Bryce Schuler is a financial advisor and certified financial planner at BaldwinClarke in Bedford. specialization in business pension plans. This series of articles reviews pension plan options for various companies. Subsequent articles discuss key principles, compare plan options, and explore implementation strategies.