The thought of giving your firm's qualified retirement plan a checkup may fillyou with dread. But it's important totake a fresh look at how your plan is set up, howmuch it costs, and the benefits it offers.Retirement plan laws change fairly frequently,and plan providers and investmentfirms are always coming up with newservices. There could be a better, morecost-effective way to design your planthat results in thousands of dollars inadditional benefits or cost savings.
For instance, a South Carolina-based orthopedic clinic revamped itsexisting retirement benefits programin a way that maximized the partners'retirement benefits, reduced totalcosts and employer contributions tothe plan, and still offered the clinic'sstaff employees an attractive, tax advantagedsavings benefit.
A DESIGN WITH PITFALLS
Ten physician partners and 75 staffemployees participated in the practice'sinitial program, which consistedof a money purchase pension plan anda profit sharing plan, both entirelyemployer-funded. The program allowed thephysicians to save the maximum amount ofassets allowed annually under the tax code, aswell as provided staff employees with a generous,and discretionary, employer contribution.
However, the program's design containedsome pitfalls. To maximize the physicians' annualretirement benefits while complying with taxrules that prevent discrimination against lower paidemployees, the firm had to make large contributionson behalf of all participants. As aresult, total plan contributions were in excess of$797,000—a substantial amount for a clinic itssize. In addition, staff employees could not maketax-deductible contributions to the plan on theirown behalf. Also, administering 2 separate plansproved cumbersome and expensive.
After carefully analyzing the practice'sexisting benefits program, 3strategies were crafted:
1. Create a single 401(k)/profitsharing plan. Merging the moneypurchase pension and profit sharingplans and adding a 401(k) salarydeferral savings feature would removesome of the practice's retirement contributionburden. The practice couldenhance the plan's attractiveness byoffering a modest employer-matchingcontribution on employees' salarydeferrals. Creating a single plan wouldalso significantly streamline planadministration and reduce costs.
2. Qualify for a "safe harbor."The new plan, of course, was still requiredto comply with nondiscriminationrules, or the physicians, as highlycompensated employees, would be unableto save the maximum pretax amount fromtheir own salaries. Vanguard proposed that thefirm adopt a "401(k) safe harbor" by making anonelective fully vested contribution on behalf ofall eligible nonhighly compensated employees.The firm would be required to make a lower contributionevery year that was also mandatory—instead of discretionary, as with the old design—allowing the new plan to automatically passnondiscrimination tests and eliminate the chancethat corrective measures, such as additional contributions,would be required for compliance.
3. Change how employer contributionsare allocated. Last, we advised the firm to calculatethe discretionary amount it contributed tothe profit sharing plan using a nonuniform formula—one that bases contributions to employeeson their position in the firm, instead of usinga formula that results in a uniform contributionfor all employees. The change would permit thepractice to contribute the maximum amountallowed annually to its physicians, yet reducetotal plan contributions. Also recommended wasthe use of special testing methods permissibleunder the Internal Revenue Code to ensure thatthe plan remained nondiscriminatory.
The contribution reductions would primarilyimpact the clinic's staff. However, the practicecould essentially offset the reductions with modest,one-time salary increases to these valuedemployees—an option the physicians very willinglychose to implement.
A REDESIGN SUCCESS
The orthopedic clinic achieved all of itsobjectives. Total plan contributions werereduced by 40%, resulting in a savings of morethan $318,000 per year. Yet the new plan stillallowed the practice to make the maximumprofit sharing contribution to the physicians,enabled the physicians to maximize their pretaxsalary deferrals, and complied with all nondiscriminationrules. Finally, the program as awhole was easier and less costly to administerand was more appealing as a tax-advantagedbenefit for the staff.
Your plan's current design may still be themost appropriate and cost-effective option foryour practice. But in the complex and ever evolvingworld of retirement plans, taking aharder look at the program's features and benefitscan pay off.
Dennis Simmons is associate counsel and principal in charge of Vanguard's Plan Consulting
Group.The Vanguard Plan Consulting Group is a specialized unit of Vanguard's Legal
ent, devoted exclusively to providing business-focused compliance and consulting
services for Vanguard's retirement savings plan clients. He welcomes questions or comments at 800-890-8502.