By: A.J. Cook


Selecting a retirement plan for your business is more complicated than buying a car, but the basic rules are the same: kick the tires before choosing.

Some plans give the employer flexibility in the amount of contributions, some don't; some plans are simple, some are not.

Retirement plans can be qualified or non qualified. Qualified plans must meet a number of requirements including not discriminating in favor of owners or highly compensated employees. Non qualified plans don't have this limitation. So, they're often used for one or only a few key officers.

Most companies choose a qualified plan. These give the employer a current deduction with no tax to the employee until he withdraws the funds. Tax can be delayed further by rolling the funds over to an IRA. Qualified plans include defined contribution, defined benefit and simplified. In defined contribution, each participant has an account, and benefits depend on what's in it at retirement. The account increases with contributions (by the employer and/or employee), and income and decreases for losses and expenses. As you can see, market fluctuations on securities affect benefits at retirement.

Here are four popular defined contribution plans:

401(k). Employees have an option – direct part of their compensation into the fund and delay taxes, or pocket all their compensation and pay taxes now. The employer may match the employees' contribution partially or completely or pay an unmatched amount. This is very popular with medium size firms. It can be a low cost method of providing tax deferred retirement savings for employees.

Profit Sharing. The annual contributions can be a percent of employer profits or at the employer's discretion. Employers love this latter option because they don't have the pressure to meet funding requirements during years of limited available cash.

Money Purchase Pension. Contributions are made as the plan requires. This is usually a percent of compensation or a flat dollar amount. The employer doesn't have the continuing flexibility on contributions available under the profit sharing plan.

Employee Stock Ownership. This has unusual characteristics. It invests primarily in employer stock and can borrow from the bank to buy the stock. The employer can contribute cash or stock, then take a deduction. Most other plans are prohibited from holding employer's stock. The ESOP also provides some surprising tax benefits. For example, the ESOP can purchase stock from the employer's controlling shareholder. The shareholder may defer gain recognition on the sale if certain requirements are met including investing the proceeds in certain marketable securities. And the employer may in some cases deduct dividends paid on employer stock held by the ESOP. The liberal provisions create two extra opportunities: The employees have an incentive to work hard because someday they might own the company. Second, the plan can create a market for the employer's stock.