Types of Retirement Plans

A profit sharing plan is an individual account plan where benefits are dependent upon the contribution, income, expenses, and forfeitures of the plan. It is established and maintained by an employer to provide for the participation in the profits by the employees. Profits are not required to contribute and these contributions are normally discretionary.

The term “401(k)” refers to a section of the Internal Revenue Code that allows an employee to elect to defer the receipt of, and current taxation on, a portion of current salary by contributing it to a qualified plan--a 401(k) plan. That means that each participant may elect to have a portion of their current pay placed into an account established under the plan, and that amount will grow, tax deferred, each year from investment earnings. The plan can be setup to permit Roth deferrals as well as traditional deferrals. Some 401(k) plans offer an employer matching contribution but this is not required. Also, an employer may contribute a discretionary contribution.

A Safe Harbor 401(k) Plan automatically satisfies the ADP and ACP Nondiscrimination Tests and allows the highly compensated employees to defer maximum contributions regardless of what the nonhighly compensated employees defer. This is accomplished by having the employer contribute either a 3% nonelective contribution or by providing a matching contribution formula equal to 100% of the first 3% deferred, plus 50% of the next 2% deferred. Additionally, an employer may contribute a discretionary contribution.

A Comparability plan is a type of profit sharing or 401(k) plan that allows for discretionary contributions to be split between different groups of employees and then allocated among the participants within each group. The plan is then “cross tested” (tested as a defined benefit plan) using the age of each participant in each group, which in many instances can provide a higher benefit to participants in one of the selected groups. In some cases, this plan can be designed to favor the key employees.

This type of plan allows for discretionary contributions that are allocated to participants based on their age and compensation. This means that the closer a participant is to his/her normal retirement age, the more contribution the participant will receive compared to a younger participant with the same amount of compensation. 

This plan is an individual account plan that must have a fixed contribution formula that is not based on profits. Typically, the contribution formula is based on a certain percentage of a participant’s compensation (i.e., 10% of compensation) and may be as high as 25% of the total eligible compensation.

This is a retirement plan in which benefits are definitely determinable and are usually related to an employee’s service and/or pay. This type of pension plan is not an individual account plan. Contributions are based on the amount needed at retirement to provide the promised benefit. Other characteristics include: the employer bears the cost of investment results, it is more beneficial to older employees, contributions are actuarially determined, and benefits are guaranteed (subject to the Pension Benefit Guarantee Corporation).

A cash balance pension plan is a defined benefit plan, but unlike regular defined benefit plans, this type of plan is maintained on an individual account basis, much like a defined contribution plan. The cash balance plan also acts similar to a defined contribution plan because changes in the value of the participant's portfolio does not affect the yearly contribution.

A stock bonus plan is an individual account plan established and maintained by an employer to provide benefits similar to those of a profit sharing plan. The purpose is for allocating and distributing employer stock that is to be shared among the employees. Current investments in employer securities are permitted but are not required (employer securities may only be required when needed for a distribution).

This is a special type of a stock bonus plan designated to invest primarily in qualifying employer securities by borrowing from, or on the credit of, the company or its shareholders. This plan type is either leveraged (plan borrows funds to purchase company shares) or nonleveraged (company makes annual stock contributions to the plan and there is no outstanding indebtedness).

This type of plan is a mixture between a defined benefit and a money purchase pension plan. It is similar to a defined benefit plan in that the annual contribution is determined by the amount needed to accumulate a fund sufficient to pay a projected retirement benefit (the target benefit). It is similar to a money purchase pension plan in that a contribution is required each year and it is placed in an individual participant account where it receives the plan’s investment results.

Through the use of permitted provisions, hybrid plans can be created to provide a retirement program that meets the needs of the employer and employees. Also, a combination of plans such as a Cash Balance Plan and a 401(k) Safe Harbor Plan can give greater benefits than using one retirement plan.