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Not All Retirement Plans are Created Equal by Tom Zgainer

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How a strategically designed retirement plan can increase your opportunities for a comfortable retirement.

by Tom Zgainer

While establishing a retirement plan for your company can provide a number of near and long-term benefits, it is wise to look at a number of factors to determine the plan that best suits your personal and corporate objectives. Oftentimes an employer implements a plan without considering that the employer might subject itself to unintended costs and liabilities. Retirement plans have specific requirements related to factors such as eligibility, employer contributions, vesting and compliance tests among many others. All these items should be part of a consultative discussion you have with the plan providers you are considering working with.

The initial question, however, is why do you want to set up a plan in the first place? Is it primarily to accelerate your personal retirement planning, or is it to provide an additional benefit to staff in order to attract and retain employees to help build a profitable practice, or is it some combination of these reasons? While that might sound like a simple question, it can have a number of related answers. Getting to understand the various types of retirement plan options available to you will help guide you to the best type of plan for you, and the underlying design of the plan itself. SIMPLEs (Savings Incentive Match Plan for Employees of Small Employers), SEPs (Simplified Employee Pension Plans), 401(k) profit sharing plans, Defined Benefit and Cash Balance plans all have their place. And what might sound like the best fit for you today might not be a good fit in the future as your personal objectives and employee make-up change over time.

It is also important to be cognizant that setting up a retirement plan gives you some additional roles like plan fiduciary and trustee, along with new fee disclosure rules beginning next April that you need to understand. Spending some time to learn more about the points covered here will go a long way to helping you establish a successful retirement plan for you and your employees.

Comparing and Understanding Plan Types
Understanding which plan best fits your current personal and corporate objectives is important.

If you have a 401(k), Profit Sharing, SIMPLE or SEP retirement plan, this is a great time of year to review your plan to be sure that what you have in place today is what you will need in for the rest of this year and beyond. SIMPLE 401(k) plans are great when first starting out, but oftentimes business owners feel constrained by their lower contribution limits as compared to a 401(k), so now is the time to see if an alternative retirement plan might be part of your strategy going forward.

With a SIMPLE, due to a provision called the Exclusive Plan Rule, you can switch to a 401(k) plan only in January of the following year, so you’ll want to be sure you are not limiting your contribution goals with the reduced limits within a SIMPLE as compared to a 401(k). Also, the 2012 deferral limits for a SIMPLE are $11,000 compared to $17,000 for a 401(k), a significant difference over time. With SEPs, oftentimes during the course of a year, employees become eligible for the same employer contribution percentage you might be paying yourself. This can become quite cost prohibitive for you. If you have a SEP, be sure to confirm with your provider/advisor/CPA as soon as possible what your contribution obligations will be to avoid any unpleasant surprises.

New Comparability Profit Sharing Plans
Business owners often ask how they can skew retirement plan benefits to themselves or to their key employees. The Internal Revenue Code restricts the ability of a sponsor of a taxqualified retirement plan to do so: a plan will not be tax-qualified if it discriminates in favor of a “highly compensated” employees (HCE). In general, such an employee is either greater than a five percent owner of the employer or an employee that earned more than $115,000 in the prior plan year.

A way for business owners to maximize the defined contribution benefits for them and their key employees is through the use of a “new comparability” contribution formula to help satisfy the onerous non-discrimination and top-heavy requirements of the Internal Revenue Code.

With respect to employer contributions to a defined contribution retirement plan, the “anti-discrimination” rule generally means that if an employer provides a contribution to a plan on behalf of an HCE as a certain percentage of the HCE’s compensation, the employer must provide a contribution to the plan on behalf of a non-HCE in the same percentage of compensation. This is known as a “pro rata allocation.”

Some exceptions to this rule exist, such as the doctrines of “integration” and “new comparability” (also known as “superintegration” or “tiered allocation”). The contribution doctrine of integration means that an employer must make disproportionately greater Social Security contributions on behalf of lower paid employees than on behalf of higher paid employees. Since Social Security is a type of retirement plan, the code permits an employer to offset the payment of greater Social Security contributions for lower-paid employees by allowing the employer to provide a disproportionately greater share of contributions to a retirement plan on behalf of higher compensated employees. If a plan is integrated, the employer need not provide a strict pro rata allocation contribution.

With regard to the doctrine of new comparability, discrimination is examined on a “benefits” (as opposed to “contributions”) basis. Contribution amounts for all recipients are converted to a benefit at age 65. A benefit accrual rate for each is then determined and tested to ensure that it is not discriminatory. Since the select employees are often the business owner(s) and are usually older employees, they have less time to reach retirement age than do younger employees. An older employee needs to receive a disproportionately greater share of contributions than would a younger employee in order to receive an equal benefit at retirement age. That is why the select employees may receive a disproportionately greater share of contributions under this doctrine, the plan can be determined to be non-discriminatory and the tax-qualification rules of the code will be satisfied.

New comparability will often be more beneficial to the employer than integrated plans. This is because a new comparability plan provides a maximum benefit for the HCE’s or select employee group, while providing the lowest possible contribution for the non-HCE’s on non-key group allowed by law. Finally, it is often advantageous from an employer’s perspective that the exceptions to the pro rata allocation formula can be used in a discretionary profit-sharing plan. This is because such a plan does not require that contributions be made to it year after year. Thus, if an employer has a poor year economically, the employer need not make a contribution to the plan unless it is top heavy.

Defined Benefit and Cash Balance Plans
High net-worth individuals have a constant need to maximize the bottom line. One effective way to accomplish this goal is to generate higher tax deductions by accelerating contributions. It’s important to not overlook the role that a properly designed retirement plan can play in helping you shield more of your income from the tax collector while increasing your retirement savings.

Defined Benefit and Cash Balance enable successful business owners to keep more of their income while providing an improved retirement benefit. For the sole proprietor who requires a higher tax deduction than the 25 percent/$49,000/ $54,500 found in a defined contribution plan, installing a traditional defined benefit plan can produce significant contribution and tax benefits.

A defined benefit plan promises a specified monthly benefit at retirement for life. The plan might state this promised benefit as an exact dollar amount, such as $100 per month at retirement. The annual benefit is defined as an accrual of a monthly benefit payable at retirement age, based on current and/or past compensation history. The maximum benefit is based on an annual benefit payable every year for life starting at age 62. That maximum is currently $195,000 (indexed).

The maximum contributions depend on the age and compensation of an individual with annual contributions for one individual as high as $200,000. The older the individual, the younger the assumed retirement age, the higher the potential limit. The ultimate benefit is totally dictated by plan terms with the employer responsible for all investment returns.

The maximum benefit limit of $195,000 at age 62 has an equivalent lump sum value of more than $2.4 million. A sole proprietor earning $500,000 at age 60 with a 25 percent SEP plan probably requires a higher tax deduction than the $49,000 with a defined contribution plan. Installing a traditional defined benefit plan can mean a new contribution of $200,000 that might more closely meet the needs of that individual.

Cash Balance Plans
For the owner of a successful company with two or more employees, a Cash Balance plan can allow the owner to pay less in overall pension benefits to the rank and file, while increasing their own retirement savings and obtaining a higher tax deduction. Cash Balance plans have several attractive features for small businesses. Contribution limits can be much higher than a defined contribution plan, the benefits formula for owners can be substantially higher than for non-owners (but only if nondiscrimination testing is satisfied), and the owner can maximize discrimination and dollars by pairing a Cash Balance plan with a 401(k) profit sharing plan.

A Cash Balance plan is a defined benefit retirement plan with an unusual contribution feature. It is used in cases where the owner wishes to benefit key employees and where the owner desires to have deductible contributions in an amount greater than the maximum contributions that can be made on behalf of a participant in a defined contribution plan (currently an annual $50,000 or $55,500 for an individual over 50).

Although a Cash Balance plan is classified as a defined benefit plan, it resembles a defined contribution plan from the perspective of a participant. In this regard, although the assets are commingled to provide benefits to all participants, a hypothetical account is maintained for each participant, the plan sponsor makes annual contributions, and interest is credited to each account.

The fictional contribution to the account is either a percentage of a participant’s compensation or is a flat dollar amount. The interest credited is either a fixed rate (e.g., five percent) or tied to an index (e.g., the 30- year Treasury bond rate). Since a Cash Balance plan is a defined benefit plan, its benefits are based on the plan’s benefits formula as opposed to the actual investment earnings on plan assets. In addition, actual investment earnings of the plan assets do not affect the amount of balances in plan accounts. That’s why the plan sponsor, not participants, bears the investment risk.

At a minimum, it might be worth your time to see how each type of retirement plan might fit your own personal and business objectives. An experienced third-party administrator or actuary can gather your census information and run a number of illustrations to show you the various advantages and disadvantages which are a function of the amount of contributions you wish to make, and your employee demographics. Doing so will go a long way in helping you increase the odds that you will have a comfortable retirement to reward you for your years of active practice.

Author Bio
Tom Zgainer is Sr. Vice President of Sales and Business Development for ExpertPlan, Inc. He has helped more than 2,300 small businesses establish a new or improved retirement plan over the past decade. Much of his focus has been on strategic plan designs for dentists, doctors and anesthesiologists. ExpertPlan, www.expertplan.com, is one of the country’s largest independent retirement plan providers, with more than 18,000 clients. Mr. Zgainer can be reached at tzgainer@expertplan.com.
Dentaltown Magazine
September 2025
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