If you’ve spent years building up a business, it may be time to reap the rewards of a high salary and other benefits, even if it’s no longer a one-person show. Still, strict nondiscrimination rules in the tax law mean that you can’t enjoy outsized benefits from your company’s retirement plan, even if you had to skimp on your contributions to the plan earlier in your career in order to help the business grow.
But there's more than one way to slice the retirement plan pie. If your firm adopts a feature for qualified retirement plans that turns it into "age-weighted plan," the benefits may be skewed in favor of older plan participants such as yourself. Best of all, this type of retirement plan comes with a stamp of approval by the IRS, so you shouldn’t have problems as long as you observe all of the legal requirements.
Start with the basic premise that an age-weighted plan is a sort of profit-sharing arrangement governed by the usual rules and limits for defined contribution plans. Just like the more prevalent 401(k) plan, the total annual contributions to the age-weighted plan made on behalf of an employee can’t exceed $54,000 in 2017. What’s more, the maximum amount of compensation that may be taken into account for plan purposes is $270,000. And deductible contributions generally are limited to the lesser of 25% of an employee’s compensation or $54,000.
Another important rule prohibits excessive benefits from going to "key employees" of the firm. If key employees receive more than 60% of the benefits, certain minimum contributions must be made to non-key employees' accounts under the tax law’s "top-heavy" rules. For this purpose, a key employee is defined in 2017 as someone who is either:
An officer of the company who has annual compensation of more than $175,000;
An employee who owns 5% or more of the business; or
An employee owning more than 1% of the business who earns more than $150,000 for the plan year.
As with other profit-sharing plans, the company isn’t required to provide a minimum dollar amount of contributions on behalf of employees during the year. That gives the company flexibility to adjust contributions up or down and to skip them altogether in a particularly bad year.
But what sets an age-weighted plan apart from most other profit-sharing plans is that a company gets to use a discretionary formula based on the age of its employees. That may result in your company making bigger contributions on behalf of older employees than are made for younger employees.
How much more in the way of retirement plan benefits can an older employee receive than his or her younger cohorts? The exact calculations depend on a number of variables – including the respective ages and salaries of all the full-time employees of the company – and should be left to actuaries and other experts in the field. This is not an analysis you should attempt on your own.
Nevertheless, to give you a rough idea of how an age-weighted plan might work out, the allocation percentage for a 55-year-old participant might be twice the percentage allocated to a 45-year old participant and three times the resulting percentage for a 35-year-old worker. Thus, the younger the employees of the firm are, the bigger the potential payoff for an older employee who is the owner of a small business or one of the top officers of a company. Again, these are just approximations and actual figures will differ.
Just remember that you can't go overboard in this respect because of the rules for top-heavy plans. The plan must adhere to this important requirement and all the other restrictions in the law.
Bottom line: An age-weighted plan can provide a greater share of retirement benefits to older plan participants, but this setup isn't for everyone. Consider all of the implications before making a commitment. Note that an age-weighted feature can be added to an existed profit-sharing plan or an employer may create a brand-new plan. We can provide guidance in this area.
This article was written by a professional financial journalist for Preferred NY Financial Group,LLC and is not intended as legal or investment advice.