As your business grows and you add staff, choosing benefits and retirement plans becomes more complicated. You have many options to choose from. That variety, however, gives you a better chance of picking a plan that can more precisely meet your needs - such as rewarding key employees, beefing up their savings, and providing incentives for them to stay with your company.
At the same time, as competition and other forces strain company profits, business owners are looking for ways to gain more value from their executive benefit dollars. The dilemma faced by small business owners is how to control benefit costs, while providing enough sweeteners to keep their top workers happy.
The first step in designing an incentive plan for your best employees, without incurring huge expenses, is to identify exactly who those key employees are. Once you have narrowed down that number, you should meet with them privately to discuss their individual needs. Their goals may range from wanting long-term financial security to sheltering their retirement nest-eggs from excessive taxation.
Understanding what is important to them will help you assess the type of plan that will interest them most. At the same time, these employee discussions are a good opportunity for you to express your desire to keep these workers satisfied, what they can expect in terms of a retirement package, and what is expected of them in return.
Traditional qualified retirement plans, such as defined benefit pension plans and 401(k) defined contribution savings plans have long been used to compensate and motivate upper-level employees. A qualified plan is entitled to special tax treatment. Employers can deduct contributions made to the plan on behalf of employees at the time the contributions are made. Employees pay no current taxes on the retirement fund until they begin drawing it out, usually years later when they retire. Additionally, the year-to-year earnings build up inside the fund free from taxes until withdrawal. In order for a plan to be qualified however, it must comply with several Internal Revenue Service and Department of Labor rules, including complex participation, funding and vesting requirements. Tax-qualified plans also can't discriminate in favor of highly-paid employees. Because of these rules, qualified plans are essentially geared to cover rank-and-file employees, not provide wealth accumulation vehicles for top management.
In recent years, qualified plans have become less attractive to employers for two reasons: burdensome regulations have driven up compliance costs and Congress has limited their benefits. To combat these problems with qualified plans, some companies are supplementing or replacing traditional pensions with so-called "nonqualified plans" to attract and retain highly compensated employees.
Nonqualified plans include many types of deferred compensation arrangements such as supplemental executive retirement plans (SERPs). In general, a nonqualified plan is an unsecured promise by the employer to pay future benefits to a select group of employees.
One advantage offered by SERPs and other nonqualified plans is their exemption from the strict vesting, non-discrimination, and reporting requirements that govern qualified plans - which can cost employers thousands of dollars in annual compliance fees. With these plans, you can discriminate in favor of key employees. For instance, you can set up a program for just one employee or a single group of workers, thus avoiding the expense of providing benefits to your entire staff.
These plans provide business owners with the flexibility to selectively reward and retain key employees, while allowing employees to replace benefits lost by government-imposed limits on qualified pension plans. For instance, your nonqualified plan could ignore the $255,000 compensation cap in 2013 and sweeten the pot by adding in a manager's bonus in defining her compensation.
Nonqualified plans are unfunded, meaning they are promises to pay from the company's reserves or general assets. Employers have no legal obligation to set aside money or other assets outside their control to secure the benefit. That gives employers control over the benefit amounts, the assets supporting the benefits, and the timing of payouts. Typically, the employee forfeits the benefit if employment ends before his retirement, disability, death, or other specified event.
There's a big disadvantage with nonqualified plans, however. Employers get no immediate tax deduction, unlike with pensions and other qualified plans. Contributions to a nonqualified plan are only deductible when the worker begins receiving the benefit, which may be 20 or more years in the future at retirement. If the SERP is properly set up, employees will not be taxed on plan contributions as they are made. One small manufacturer, for instance, set up a nonqualified plan so that its top three managers could defer a portion of their bonuses, as well as the income taxes on those sums, until they retired.
One commonly used nonqualified deferred compensation arrangement plan is the salary continuation plan. These plans are generally funded on the employee's behalf from the employer's current earnings. Amounts contributed by the company may be subject to vesting schedules that are mutually acceptable to both employer and employee. Vesting arrangements can be tailored to meet your specifications - such as increasing benefits by a certain percentage for each year of service - and to encourage employees to remain with the company.
Employers fund nonqualified plans in a number of ways. Some may choose to pay benefits out of cash flow on a pay-as-you-go basis. However, this may leave executives concerned about the financial risk to which their future benefits are exposed. In order to provide these executives with greater security, some employers finance these arrangements through life insurance.
For example, an employer can purchase life insurance (known as corporate-owned life insurance) in which the employer is both the owner and beneficiary of the policy. The policy can provide the opportunity to set aside money over the active working life of the employee and, if properly structured, will usually generate tax-deferred income.
In a typical salary continuation plan, the company might promise a key employee a ten-year benefit starting at age 65. If he dies before then, his beneficiary receives a similar benefit. The company's obligation is backed by the life insurance policy on the employee. Additionally, the policy could be designed to allow the employer to recover the cash value at premature termination by the employee.
Attracting and holding on to top employees today calls for creative solutions. There are many ways to help provide the long-term security and other financial incentives these employees want. See a professional financial advisor for help in determining the most cost efficient way to meet their needs, and yours. *Withdrawals of earnings are taxable as ordinary income and, if taken prior to age 59½, may be subject to a 10% federal tax penalty.