No. of Recommendations: 0
>>Here's a brief description of all three (i.e., money purchase, profit sharing and 401k).

If I may add a bit to the descriptions of the PS plan and the MP plan for the benefit of any business owners out there, Pixy:

In both the PS and MP plans it is possible for the plan to provide a higher percentage to certain highly compensated employees. One way is to use what is called "permitted disparity". The whole idea with this is the plan is allowed to discriminate in favor of employees who make more than the Social Security wage base (68,400 for 1998) to make up for the fact that SS discriminates against these folks. Typically you can get about a 3% difference in the contribution rate for the highly paid person versus the lower paid person.

But the real exciting development over the past 7 years or so is a plan design that variously goes by the name of "cross-tested", "tiered", or "new comparability". These plans can provide a significant difference between the higher paid folks and the lower paid folks because they measure discrimination by converting the contribution to equivalent benefits at age 65 and then compare those benefits as a percent of pay. They are a way for owners of small (and not so small) companies to set up plans that provide up to a 25% of pay contribution to themselves without having to give 25% for the rank and file. When used in a Profit Sharing plan a 401(k) feature is often included to allow the rank and file to bump up their own retirement savings.

A simple example will give the flavor of how these plans work (although it is simplified a little). Say you have a two-person company, an owner aged 55 making $160,000 and 2 employees aged 30, each making $40,000. Say the goal is for the owner to get a contribution of $30,000. Under IRS rules we can convert this to an annual benefit at age 65 by accumulating it at a stated interest rate (the highest allowed is 8,5%) to age 65 and then converting it to a life annuity (I use 9 for the annuity factor and that meets IRS rules) In this case the accumulation at age 65 would be 67,830, the annual benefit would be 7,537, and that would represent a benefit of 4.710% of pay.

Now assume the plan gives the 2 employees 5% of pay each, or $1,500. Accumulating it to age 65 gives an accumulation of 26,069, the annual benefit would be 2,897, and that would represent a benefit of 9.65% of pay. Since the 9.65% benefit they are receiving exceeds the 4.710% of pay the owner is getting the plan satisfies the discrimination requirements.

This kind of plan will cost more to set up and administer than a plain vanilla plan, but frequently the results are well worth it. Any technically competent pension administration firm can set this type of plan up.

Sorry to be so long winded.

Print the post  


The Retirement Investing Board
This is the board for all discussions related to Investing for and during retirement. To keep the board relevant and Foolish to everyone, please avoid making any posts pertaining to political partisanship. Fool on and Retire on!
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.