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EMPLOYEE BENEFITS*:
How To Handle Them
Premier Capital Management, Inc. Insurance Services is a true
brokerage firm. We do more than just shop for the best price. We
design a plan that delivers you and your employees the best value
for your investment. The variety of health care insurance products
and coverage plans available provide a wide range of costs and
benefits.
Many companies offer a variety of employee benefits to their
staff in order to keep them satisfied. The types of benefits
include, but are not limited to, health insurance, retirement plans,
vacation and sick leave. This Financial Guide provides an overview
of the types of benefits that businesses provide for employees and
what’s involved in offering them. We can design the plan that’s the
best fit for your business and employees. Ask us about how our
employee benefits communication service ensures your company is in
compliance with federal and state laws.
TABLE OF CONTENTS
Click on any of the topics in the Table of Contents listed below to
go directly to that discussion.
Employee benefits play an increasingly important role in the
lives of employees and their families, and have a significant
financial and administrative impact on a business. Most companies
operate in an environment in which an educated work force has come
to expect a comprehensive benefits program. Indeed, the absence of a
program or an inadequate program can seriously hinder a company's
ability to attract and keep good personnel. Employers must be aware
of these issues and be ready to make informed decisions when they
select employee benefits.
Designing the right benefit plan for your employees is a complex
task. There are many issues to consider, including tax and legal
aspects, funding, and finding the right vendors or administrators.
This Financial Guide describes the basics of an employee benefits
program.
WHAT IS AN EMPLOYEE BENEFIT PLAN?
An employee benefit plan protects employees and their families
from economic hardship brought about by sickness, disability, death
or unemployment. It also provides retirement income to employees and
their families. And it provides a system of leave or time off from
work.
Mandated Benefits
The employer must pay in whole or in part for certain legally
mandated benefits and insurance coverage:
• Social Security.
• Unemployment insurance.
• Workers' compensation.
Funding for the Social Security program comes from payments by
employers, employees and self-employed persons into an insurance
fund that provides income during retirement years. Full retirement
benefits normally become available at age 65. For younger
individuals the date for maximum benefits is being adjusted to age
67. (These benefits are discussed in more detail in the Retirement
Benefit Plans section of this Financial Guide.) Other aspects of
Social Security deal with survivor, dependent and disability
benefits, Medicare, Supplemental Security Income and Medicaid.
Related FG: For a detailed discussion of these benefits, please see the
Financial Guide SOCIAL SECURITY BENEFITS: How To Get The Maximum
Amount.
Unemployment insurance benefits are payable under the laws of
individual states from the Federal-State Unemployment Compensation
Program. Employers contribute to the program based on total payroll.
Workers' compensation provides benefits to workers disabled by
occupational illness or injury. Each state mandates coverage and
provides benefits. In most states, private insurance or an employer
self-insurance arrangement provides the coverage. Some states
mandate short-term disability benefits as well.
Optional Benefits
A comprehensive benefit plan can include the following elements:
A benefit plan can also include bonuses, service awards,
reimbursement of employee educational expenses and prerequisites
appropriate to employee responsibility.
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WHY OFFER YOUR EMPLOYEES BENEFITS?
Here are some of the reasons employers offer benefits:
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To attract and hold capable people.
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To keep up with competition.
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To foster good morale.
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To keep employment channels open by providing opportunities
for advancement and promotion as older workers retire.
A combination of benefits programs is the most effective and
efficient means of meeting economic security needs. For many
employers, a benefit plan is an integral part of total compensation,
because employers either pay the entire cost of a benefit plan or
have employees contribute a small portion of premium costs for their
coverage.
HEALTH, DISABILITY, AND LIFE INSURANCE PLANS
Employers might offer medical and dental plans, disability
benefits, and life insurance.
Medical and Dental Plans
A serious illness or injury can be devastating to an employee and
his or her family. It can threaten their emotional and economic
well-being. Thus, adequate health insurance is important to
employees and is part of a solid group plan.
Group health plans help attract and keep employees who can make
your business a success. They relieve your employees of the anxiety
of health care costs by providing the care they need before illness
becomes disabling, thus helping you avoid costly employee sick days.
Group health plans usually cost less than purchasing several
individual policies with comparable coverage. Moreover, there are
tax advantages to offering health care benefits: your contribution
as an employer may be deductible and the insurance is not taxable
income to your employees.
As an employer, you can choose either an insured (also known as
an indemnity or fee-for-service plan) or a pre-paid plan (also known
as a health maintenance organization).
Traditional Indemnity Plans. An indemnity plan allows the
employee to choose his or her own physician. The employee typically
pays for the medical care and then files a claim form with the
insurance company for reimbursement. These plans use deductibles and
coinsurance as well. A deductible is a fixed amount of medical
expenses an employee pays before the insurance plan reimburses any
more expenses. The deductible can range from $100 to $1,000 a year.
Coinsurance is a percentage of medical expenses the employee pays,
with the plan paying the remaining portion. A typical coinsurance
amount is 20%, with the plan paying 80% of approved medical
expenses. Listed below are the most common types of insurance
arrangements (indemnity plans) providing health care to groups of
employees.
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A basic health insurance plan, covering hospitalization,
surgery and physicians' care in the hospital.
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A major medical insurance plan, usually supplementing a
basic plan by reimbursing charges not paid by that plan.
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A comprehensive plan, covering both hospital and medical
care with one common deductible and coinsurance feature. This
line below needs to be taken out.
Health Maintenance Organizations. Health maintenance
organizations (HMOs) provide health care for their members through a
network of hospitals and physicians. Comprehensive benefits
typically include preventive care, such as physical examinations,
well baby care and immunizations, and stop-smoking and weight
control programs.
The main characteristics of HMOs are as follows:
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The choice of primary care providers is limited to one
physician within a network; however, there is frequently a wide
choice for the primary care physician.
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There is no coverage outside the HMO network of hospitals
and physicians.
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Costs are lower, due to limited choice. Physicians are
encouraged to keep patients healthy; accordingly, they often are
paid on a per capita basis, regardless of how much care the
patient needs.
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The employer prepays HMO premiums on a fixed, per-employee
basis.
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Employees do not have to apply for reimbursement of charges,
but they may have small co-payments for medical services.
Preferred Provider Organizations. Preferred provider
organizations (PPOs) fall between the conventional insurance and
health maintenance organizations, and are offered by conventional
insurance underwriters. A PPO is a network of physicians and/or
hospitals that contracts with a health insurer or employer to
provide health care to employees at predetermined discounted rates.
Some of the key elements of a PPO are:
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It offers a broad choice of health care providers. Because
of the broader choice of providers, PPOs are more expensive than
HMOs.
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It may have less comprehensive benefits than HMOs, but the
benefits usually can meet almost any need.
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PPO providers usually collect payments directly from
insurers.
Although there is no requirement for employees to use the PPO
providers, there are strong financial reasons to do so.
Dental Benefits. Medical insurance frequently includes
dental plans. Most plans cover all or portions of the cost for the
following services:
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Cleaning, x-rays and oral examinations.
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Fillings.
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Crowns and dentures.
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Root canals.
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Oral surgery.
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Orthodontia (these portion of the cost covered here are
generally quite limited, if at all)
Dental care is an important part of healthy
living. And employees value an affordable dental benefit plan.
Adding or upgrading your company's dental benefit plan is a simple
yet very effective way to attract and retain good employees. There
are a wide range of dental plans. Let us help you select the plan
that’s the right fit for your business.
Health Savings Accounts. The HSA allows employees to
deduct contributions to the HSA even if they do not itemize
deductions. The HSA plan allows employees who are covered by a
high-deductible health plan to contribute pre-tax amounts that will
be used to cover medical expenses or used later for retirement.
Qualified amounts contributed to an employee's HSA by an employer
can be excluded by the employee. Distributions from the HSA are not
taxable as long as they are used for medical expenses.
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Health Savings Accounts (HSAs) at a glance
History
The Health Savings Account is part of the prescription drug bill
passes by the United States Congress in December of 2003. It allows
consumers the choice of purchasing a high deductible health
insurance plan, and putting the money saved into a tax free account
used to pay for health care costs.
Frequently asked questions
Q: What is an HSA?
A: A Health Savings Account (HSA) is an individual or joint
account established for the purpose of paying for healthcare and
medical expenses. It may be funded by the savings obtained by
switching to a high deductible-low cost health insurance plan
(defined as a health plan with a minimum deductible of $1,050 for
individuals and $2,100 for families). The money put into an HSA is
tax deductible, grows tax free, and withdrawals are tax free if used
to pay for medical expenses.
Q: How much can be contributed to an HSA?
A: Up to 100% of a health plans annual deductible (maximum of
$2,700 for an individual, and $5,450 for families)(additionally a
catch-up contribution for those over age 55 is available, the 2006
limit is $700).
Q: How is an HSA funded?
A: It can be funded by an employer as a pre-tax payroll
deduction, by an individual, or both. Contributions may be made
monthly, or as a lump sum payment. Family members may also
contribute to an HSA on behalf of another family member as long as
that other member is eligible. As with an IRA, monthly statements
and year-end tax statement is provided.
Q: Can money in an HSA be invested?
A: Yes, since the money in an HSA belongs to the individual or
family establishing the account, it can be invested as they see fit.
Q: What happens if there is money left over at the end of the
year?
A: Any money left in an account at the end of the year will
continue to earn tax-free interest, like an IRA, and may continue to
grow indefinitely. After age 65 funds may be withdrawn tax-free for
non-medical expenses, thus providing a tool for retirement planning.
Q: How are funds accessed?
A: Funds can be accessed through reimbursements. Some HSA account
administrators may provide a debit card and/ or checks to use to pay
for qualified medical expenses.
Q: Can HSA funds be used for non medical expenses?
A: Yes, but a 10% penalty will apply.
Q: What happens to HSA funds if an individual switches to another
health insurance plan?
A: Funds will continue to grow, and can be used to pay for
qualified medical expenses, but contributions cannot be made to the
account.
Q: What are qualified expenses?
A: Qualified expenses include doctor’s office visits,
deductibles, dental expenses, prescription drugs, and many expenses
not covered by traditional insurance plans. Also included are
certain insurance premiums such as COBRA coverage, Medicare
premiums, and Long Term Care insurance premiums.
Summary
An HSA puts the individual in control of their healthcare funds.
It encourages the consumer to be informed of medical treatment
options, and allows them to see the medical professionals they
prefer, whether in or out of the preferred network of the insurance
plan.
Disability Benefits
A disability plan provides income replacement for the employee
who cannot work due to illness or accident. These plans are either
short-term or long-term. They can be distinct from workers'
compensation because they pay benefits for non-work-related illness
or injury.
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Short-Term Disability. A short-term disability is usually
defined as an employee's inability to perform the duties of his
or her normal occupation. Benefits may begin on the first or the
eighth day of disability and are usually paid for a maximum of
26 weeks. The employee's salary determines the benefit level,
ranging from 60 to 80% of pay. You, as an employer, may specify
a number of days of sick leave paid at 100% of salary. The
employee can use these before short-term disability begins.
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Long-Term Disability. Long-term disability (LTD) benefits
usually begin after short-term benefits conclude. LTD benefits
continue for the length of the disability or until normal
retirement. Again, benefit levels are a percentage of the
employee's pay, usually between 60 and 80%. Social Security
disability frequently offsets employer-provided LTD benefits.
Thus, if an employee qualifies for Social Security disability
benefits, these are deducted from benefits paid by the employer.
Every company’s needs are different when it
comes to Disability Insurance. Some employers only want to cover key
employees and so Individual Disability Insurance is needed. Other
companies want to provide coverage for all of their employees and so
Group Disability Insurance is in order. Still others want to provide
the opportunity for their employees to purchase coverage at their
own expense - so Voluntary Disability Insurance is needed.
Regardless of what your company’s needs are
– a salary continuation plan can be easy to develop. By establishing
a formal plan funded by disability income insurance you are
protecting your business – and your employees. We can develop a plan for you.
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Life Insurance
Traditionally, life insurance pays death benefits to
beneficiaries of employees who die during their working years. There
are two main types of life insurance:
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Survivor income plans, which make regular payments to
survivors.
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Group life insurance plans, which normally make lump-sum
payments to specified beneficiaries.
Protection provided by one-year, renewable, group term life
insurance, with no cash surrender value or paid-up insurance
benefit, is very popular. Frequently, health insurance programs
offer this coverage.
You should use the same principles for selecting a life insurance
program as you do for selecting health insurance. Finding a benefit
plan that meets your budget constraints and fills the needs of your
employees is crucial. Among the sources to check are:
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Your local chamber of commerce.
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Independent insurance agents.
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Trade associations of your business.
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State departments (or commissions) of insurance.
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Community business leaders.
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Benefit consultants or actuaries.
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Service Corps of Retired Executives (SCORE) (affiliated with
the U.S. Small Business Administration).
 TIP:
To reduce risk, select insurance companies with top ratings from
Best’s (Best Insurance Reports: Property-Casualty Ed. and
Life-Health Ed. Published annually by A.M. Best Company, Oldwick,
N.J.). HMOs and Blue Cross/Blue Shield are not rated by Best, but
are regulated by state governments. Please refer to Standard &
Poor's Financial Strength Ratings, in order to select the right
insurance company.
TIP:
Check with other users and state regulators on the history of the
particular plan you are considering. Self-Insurance Rising costs are
prompting small business owners to take a look at a form of health
care coverage previously considered an option only for big business:
self-insurance. With self-insurance, the business predetermines and
then pays a portion or all of the medical expenses of employees in a
manner similar to that of traditional health care providers. Funding
comes through establishment of a trust or a simple reserve account.
As with other health care plans, the employee may pay a portion of
the cost in premiums. Catastrophic coverage is usually provided
through a "stop loss" policy, a type of coinsurance purchased by the
company.
The plan may be administered directly by the company or through
an administrative services contract.
The advantages of self-insurance are listed below:
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Programs can be flexible. They are designed to reflect
employee needs, including medical and dental care, prescriptions
and so on.
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Mandated benefit laws and state insurance premium taxes do
not affect these plans.
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The employer retains control over the timing and amount of
funds paid into the plan and can manage costs more directly.
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Administration of these plans can be more efficient.
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Over time, these plans can save money.
The drawbacks to self-insurance include the following:
CAUTION:
While insurance can be a viable option for small businesses, it
should be undertaken only after careful study.
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BALANCING COST, QUALITY AND ACCESSIBILITY
In summary, when deciding on a health, disability, or life
insurance plan, consider what you and your workers want in a plan.
Determine all costs associated with the plan. Investigate the
quality of potential insurance carriers.
Examine the quality of each plan, including the benefits and
restrictions:
Check on underwriting and other restrictions that may exclude you
from the health plan:
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Employee medical histories.
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Minimum employer contribution.
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Minimum participation by eligible employees and dependents.
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Waiting periods.
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Proof of employee status.
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Purchase of other benefits.
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Other limitations — what isn't covered.
Check on the extent to which your company can control costs. This
might include prior review of hospital admissions to determine
necessity of hospitalization. Or it could mean concurrent review of
hospital stays to confirm continuing need of hospitalization.
Management programs for catastrophic cases might be used. These
programs arrange for the most cost-effective care.
Questions To Ask Before Signing a Benefits Contract
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Who is the insurance company?
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Is it committed to small business?
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How solvent is it? What is its rating?
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What is the carrier's reputation for customer service?
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What is the choice of doctors and hospitals?
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How does the company manage health care costs?
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Who administers the plan?
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What information must the employer provide?
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How are the employees enrolled?
When Problems Arise
From time to time problems arise with benefit delivery. Patience
on the part of the provider, the employer and the employee usually
brings a resolution.
Occasionally, unusually prolonged and difficult problems develop
that do not yield to resolution. Such instances should be brought to
the attention of your state's insurance department or commission,
which is responsible for regulating insurance companies.
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RETIREMENT BENEFIT PLANS
A financially secure retirement is a goal of all Americans. Since
many of us will spend one-fourth to one-fifth of our lives in
retirement, it is more essential than ever to begin preparations at
an early age. Many financial planners report that an individual
requires about 75% of his or her pre-retirement income to maintain
the same standard of living enjoyed during one's working years.
Social Security, employer-sponsored retirement programs and
personal savings are the three sources of post-retirement income.
Social Security Benefits
Social Security provides retirement benefits for most persons
employed or self-employed for a set period of time (currently 40
quarters; about 10 years). Benefits paid at retirement,
traditionally age 65, are based on a person's earnings history. The
age at which you can retire at full benefits increases depending
upon your current age. For younger individuals full benefits begin
at about age 67. Payments may begin at age 62 at a reduced rate or,
if delayed until age 70, at an increased rate.
For a person with earnings equal to the U.S. average, the benefit
will be about 40% of pay. For someone with maximum earnings, the
benefit would be about 25% of the portion of pay subject to Social
Security tax.
TIP: Every worker should understand Social Security retirement benefits.
By completing Form SSA-7004, "Request for Social Security Earnings
and Benefit Estimate Statement," you can receive a projection of
benefits. Forms can be obtained through Social Security Online,
local Social Security offices or by calling 1-800-772-1213.
Planning Aid:
To obtain an immediate copy of this form, please click on Request
for Social Security Earnings and Benefit Estimate Statement.
Employer-Sponsored Retirement Plans
A retirement plan makes good sense and can attract and reward
employees. The benefits and tax advantages of supplementing Social
Security with a qualified retirement plan are significant.
A qualified plan is one meeting IRS specifications. Currently,
such contributions are tax-deductible and earnings accumulate on a
tax-deferred basis. In addition, benefits earned are not part of the
participant's taxable income until received, and certain
distributions are eligible for special tax treatment.
Whether you are a sole proprietorship, a partnership or a
corporation (employing many people or only yourself as the
owner/employee), there are a wide range of options available. These
can range from simple plans, which you establish and maintain, to
complex versions, which require an actuary, attorney or employee
benefits consultant. If you are active in the business, you can be
included as a plan participant. Accountants, banks, insurance and
investment professionals, as well as other financial institutions,
can provide information on retirement plan products.
TIP:
Several provisions of the tax law encourage employers to involve
professionals on plan issues. Specifically, the law:
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Subsidizes the paperwork costs for small businesses setting
up a plan. It grants a tax credit for half the cost up to a
credit of $500 a year for each of the first 3 years. Since such
costs are already deductible, the deduction (less valuable than
a credit) will be for the amount of the expenses less the
credit.
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Waives (for 5 years) the fees IRS charges for issuing
determination letters (rulings) to plan sponsors on the tax
status of their plans.
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Makes employer-provided retirement planning advice a
tax-favored fringe benefit (tax-free to employee and spouse,
deductible by employer).
Depending on whether you are a sole proprietor, a partnership or
a small corporation, the following plans are available:
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Defined benefit — A retirement plan favoring older, more
highly paid employees.
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Profit-sharing — A flexible plan based on profits and
contributions that can be discretionary from year to year.
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Money purchase — A method that often favors younger workers.
Steady plan contributions are required.
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Individual retirement accounts (IRAs) — A simple plan;
allowing modest contributions.
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Simplified employee pension (SEP) — A plan for small
businesses combining features of IRA and profit-sharing plans,
offering flexibility and easy self-administration.
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401(k) — The most popular plan today for businesses with
employees, providing employees with the ability to save for
their retirement with pre-tax dollars. Can be at low cost to
employers.
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SIMPLE Plans – A new type of plan which combines IRA and
401(k) features.
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Stock bonus — Benefits in the form of company stock.
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Employee Stock Ownership Plan (ESOP) — Another plan based on
company stock.
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Designing the Right Corporate Plan
Selecting the right pension plan for a corporation results from a
process of identifying business needs and expectations, including
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Need for flexibility.
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Current age of key employees.
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Current number of employees and plans for growth.
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Maximization of retirement benefits.
Although there are many different types of retirement plan
options available to corporations, they fall into two general
categories: defined benefit plans and defined contribution plans:
Defined Benefit Plans. With this plan, the benefits an
employee will receive are predetermined by a specific formula —
typically tied to the employee's earnings and length of service. The
law allows a pension of up to $160,000 a year. This figure is
indexed for inflation; the 2004 amount is $165,000. The employer is
responsible for making sure that the funds are available when needed
(the employer bears funding and investment risks of the plan).
Such a plan can provide larger benefits faster (through
tax-deductible contributions) than other plans. The price of
providing a higher degree of tax savings and being able to rapidly
shelter larger sums of retirement capital is having to meet
additional reporting requirements. Defined benefit plans typically
cost more to administer, requiring certifications by enrolled
actuaries, and insurance payments to the Pension Benefit Guaranty
Corporation (PBGC), which may review plan terminations.
Defined Contribution Plans. Also known as individual
account plans, defined contribution plans specify the amount of
funds placed in a participant's account (for example, 10% of
salary). The amount of funds accumulated and the investment gains or
losses solely determine the benefit received at retirement. The
employer bears no responsibility for investment returns, although
the employer does bear a fiduciary responsibility to select or offer
a choice of sound investment options.
TIP:
Defined benefit plans are typically better for older employees
(usually age 45+). For example, these plans can provide the ability
to fund for years of employment before the inception of the plan.
While some contribution flexibility is available, factors
determining the cost of promised benefits (e.g., number and ages of
employees, rates of return on investments) will mandate the level of
required deposits to the plan.
There are several basic types of defined contribution plans,
including (1) simplified employee pension plans, (2) profit-sharing
plans, (3) money purchase plans, (4) 401(k) plans, (5) stock bonus
plans, (6) employee stock ownership plans, and (7) SIMPLE plans.
1. Simplified Employee Pension Plans. Simplified Employee
Pension Plans. A simplified employee pension (SEP) suits many small
corporations. It requires no IRS approval, no initial filings and no
annual reporting to the government. Although SEPs are called
"pensions," they are actually IRAs, except that contributions to
them aren't subject to the IRA dollar limits. The total deferral
each year can be up to $40,000 (indexed; the 2004 amount is $41,000)
or 25% of annual earnings, whichever is less. There is also a limit
on how much of your earnings may be included in the percentage
computation.
Contributions must be made on a nondiscriminatory basis to all
employees who are at least age 21 and who have worked for any part
of three of the past five years earning a minimal amount.
Contributions can vary from year to year — you may even skip entire
years. To be deductible for a year, contribution must be paid no
later than the due date of an employer's income tax return for the
year, including extensions. Once made, the entire contribution is
owned by the employee.
TIP:
Complete specifications for the plan can be found in IRS Form 5305.
The form itself serves as the plan document, requiring only the
insertion of business name, the checking of three boxes and a
signature. The form is not filed with the IRS, but rather copied for
all employees and then placed in the firm's files. Many employers
instead use plan documents provided by financial institutions.
2. Profit-Sharing Plans. Similar to a SEP, a
profit-sharing plan offers the flexibility of making contributions —
up to the lesser of $40,000 (indexed; the 2004 amount is $41,000) or
25% of compensation.
TIP:
Alternatively, rather than selecting a percentage, a flat amount
(for example, $100,000) could be allocated among eligible employees,
generally proportionate to compensation. Historically, contributions
were paid out of profits; this is no longer required.
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Profit-sharing plans differ from SEPs in several distinct ways.
An employer can apply a vesting schedule to the company's
contributions, based on an employee's length of service with the
company after the contribution is made. If an employee is terminated
before becoming "fully vested," his or her funds will revert to the
plan (reducing future contributions) or be reallocated among the
remaining participants. In addition, profit-sharing plans permit the
exclusion of part-time employees, and can allow participants to
borrow from the plan.
Profit-sharing plans, as all other qualified retirement plans,
require the preparation of formal master documents as well as annual
tax filings. A standardized master or prototype plan will often
satisfy requirements and will typically be less expensive and
simpler to set up and operate than an individually designed plan.
3. Money-Purchase Plans. With a money purchase plan, the
employer is usually committed to making annual contributions equal
to a designated percentage of each employee's compensation. This
percentage may not exceed 25% of compensation, with a maximum
contribution of $40,000 a year (indexed; the 2004 amount is
$41,000). Contributions must be made even in years in which there
are no profits.
4. 401(k) Plans. These tax-deferred savings plans have
become highly popular in recent years. The basic idea of a 401(k) is
simple: it is a profit-sharing plan adopted by an employer that
permits employees to set aside a portion of their compensation
through payroll deduction for retirement savings. The amounts set
aside are not taxed to the employee and are a tax deductible
business expense for the employer. Set-asides (called "elective
deferrals") for any employee can't exceed $12,000 for 2003, $13,000
for 2004, $14,000 for 2005 and $15,000 in 2006 and after. Elective
deferrals don't count in figuring the employer's deduction limits.
Thus, the employer's contribution up to the profit-sharing deduction
limit, plus the elective deferral, are tax-sheltered.
An employer's discretionary matching contribution can provide
incentive for employee participation as well as serve as an employee
benefit. Employer contributions can be capped, to limit costs, and a
vesting schedule can be applied to employer deposits (employees are
always 100% vested in their own contributions).
For employees, the opportunity to reduce federal — and often
state and local — taxes through participation in a 401(k) plan
offers significant benefits. While savings are intended for
retirement, certain types of loans can provide employees with access
to their funds — employees repay borrowed principal plus interest to
their own account.
CAUTION: Special non-discrimination tests apply to 401(k) plans, which may
limit the amount of deferrals that highly compensated employees are
allowed to make. To avoid these limits, some employer contribution
on behalf of lower-paid employees may be required.
5. Stock Bonus Plans. This is similar to a profit-sharing
plan. The plan invests in employer stock, which is generally
distributed to participants at retirement.
6. Employee Stock Ownership Plans. A special breed of
qualified plan, an employee stock ownership plan (ESOP), provides
retirement benefits for employees. In addition, an ESOP can be used
as a market for company stock, for financing the company's growth,
to increase the company's cash flow or as an estate planning tool.
ESOP funds must be primarily invested in employer securities.
ESOPs are stock bonus plans or stock bonus combined with money
purchase plans. Tax deductible contributions to the plan are used to
buy stock for eligible employees. On retirement, the employee may
take the shares or redeem them for cash. Complicated rules must be
adhered to in the establishment and maintenance of an ESOP plan.
Expert advice should be sought.
7. SIMPLE Plans. Employers with 100 or fewer employees can
establish "Simple" retirement plans. The Simple combines the
features of an IRA and a 401(k). Employees can contribute to the
Simple, pre-tax, and the employer must make a matching contribution
(usually less than the employee's). The limit on the employee's
contribution is $8,000 in 2003, $9,000 in 2004, and $10,000 in 2005
and after. The penalties for withdrawing money from the Simple
before age 59-1/2 can be higher than with other plans.
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PLANS AVAILABLE TO NON-CORPORATE EMPLOYERS
Non-corporate employers can adopt any of the plans listed above
that corporate employers can, except, of course, those based on
stock in the employer corporation (stock bonus and ESOP plans).
Defined benefit, profit-sharing, money purchase and 401(k) plans
sponsored by noncorporate employers — that is, self-employed persons
— who participate in the plans are often called "Keogh plans.
Contribution limits for unincorporated businesses are the same as
for corporate plans of the same type, except for contributions on
behalf of the self-employed owner — sole proprietor, partner or LLC
member, who for this purpose is treated as an employee.
Contributions for a self-employed owner are based on the owner's
self-employment net earnings. The contribution ceiling for money
purchase, profit-sharing and SEP plans are the same: in effect, 20%
of earnings (technically, 25% of earnings reduced by the
contribution) up to a maximum contribution of $40,000 (indexed; the
2004 amount is $41,000). For defined benefit plans, a self-employed
owner's benefit is based on self-employment net earnings less
deductible contributions.
In plans such as 401(k)s or SIMPLEs where employees defer part of
their salary, self-employed owners are deferring part of their
self-employment earnings. For employees, deferred salary is excluded
from taxable pay; for self-employed owners, deferred self-employment
earnings are deducted.
Keogh plans, like comparable corporate plans, must be
established by the end of the year (December 31) for which you are
making the contribution. Once established, you have until your tax
return filing date - including extensions - to make the
contribution.
SIMPLEs generally must be established by October 1 of the
year they go into effect.
A SEP may be established by the tax return due date,
including extensions, for the year it goes into effect. Thus, a plan
effective for 2004 can be created in 2005; contributions to that
plan in 2005 will be deductible on the 2004 return if designated as
for 2004 and made by the 2004 return due date including extensions.
Employee contributions. These are important elements of
many employer plans, allowing employees to make their own
tax-sheltered investments within the company plan.
In many cases such contributions are "pre-tax"—that is, from
salary (reducing taxable pay), as in the case of 401(k)s, SIMPLEs,
and certain SEPs, called SARSEPs, formed before 1997. Pre-tax
"employee" contributions can also be made by self-employed owners,
in which case they reduce taxable self-employment earnings. The
ceilings on such contributions are discussed above (SARSEP and
401(k) ceilings are the same).
Additional pre-tax contributions are allowed for participants age
50 or over. There is a ceiling amount of such contributions, called
"catch up" contributions (misleadingly, since the amount or lack of
prior contributions is irrelevant), for 401(k)s and SARSEPs. For
SIMPLEs, these amounts are halved.
Employee contributions may also be after-tax. That is, they are
not excludable (where made by employees) or deductible (where by
self-employed owners) but still grow tax-free once invested, until
withdrawn. The contributions come back tax-free; only the earnings
are taxed.
Employee after-tax contributions may be attached to a plan, such
as a 401(k), or be to a standalone plan (maybe called a savings
plan) for employees' contributions alone, or with some employer
match.
Credit for low-income participants. "Lower-bracket"
taxpayers age 18 and over are allowed a tax credit for their
contributions to a plan or IRA. Credit is allowed on joint returns
of couples with (modified) adjusted gross income (AGI) below
$50,000, heads-of-household below $37,500 and others (singles,
married filing separately) below $25,000. Credit is a percentage
(10%, 20%, 50%) of the contribution, up to a contribution total
(considering all contributions to all plans and IRAs) of $2,000. The
lower the AGI, the higher the credit percentage: the maximum credit
is $1,000 (50% of $2,000).
Credit is allowed whether the contribution is pre-tax (credit is
in addition to a deduction or exclusion) or after-tax.
Review plan decisions. Law changes in the recent past, and
changes described above that are scheduled to become effective in 2004 and after, suggest that business owners should reconsider the
type of plan they provide. Plans most affected are:
-
Money purchase plans. Profit-sharing plans can now shelter
as much as money purchase plans, without having to make the
commitment (required by money purchase plans) of regular,
determinable contributions each year.
-
401(k) plans can be made richer than regular profit-sharing
plans, where the employee contributes (defers) the maximum (up
to $12,000 in 2003, higher later) and the employer contributes
the maximum (up to 25% of employee pay).
-
Defined benefit plans can be funded faster with
tax-deductible contributions, and funded more richly, up to a
higher annual pension. In specific cases this can make them
preferable to other plans.
-
Contributions or benefits for higher income participants,
including owners, can be increased since rules against plan
discrimination in their favor have been eased.
Those lacking tax-favored retirement plans should give plan
adoption a new look. Those with such plans already should review the
options, and what's required to take advantage of them. Professional
guidance is essential and, as pointed out above, encouraged by the
law.
Individual Retirement Accounts. An employer may establish
IRAs for its employees to which the employees contribute, though
this is not usual. Effective starting in 2003, an employer will be
able to establish IRAs for employees within an employer plan. But
virtually all IRAs are set up by the individual worker, employed or
self-employed (occasionally for the worker's spouse) without
involvement of any employer.
An IRA is a tax-favored savings plan that allows workers to make
contributions with pre-tax dollars (where deduction is allowed, see
below) and defer taxation on earnings until retirement.
There are several limitations to IRAs:
-
Contributions for 2003 and 2004 cannot exceed the lesser of
$3,000 per year or 100% of compensation ($6,000 for a couple),
rising to $4,000 for 2005-7 (couples $8,000), and $5,000
(couples $10,000) for 2008 and after. Additional "catch-up"
contributions are allowed persons age 50 or over, of $500
(2003-5) and $1,000 (2006 and after).
-
Contributions may be made only up to age 70 1/2.
-
The account holder may not use funds to purchase life
insurance or collectibles (except gold or silver coins issued by
the U.S. Government).
-
IRA contributions up to the ceiling are deductible if
neither the taxpayer nor his or her spouse is covered by a
corporate or unincorporated retirement plan. Deduction is
limited (phases out) at prescribed income levels (which increase
each year) where the taxpayer is covered by a plan or where
(using higher levels) the taxpayer's spouse is covered though
taxpayer is not. Nondeductible contribution is allowed in other
cases, including contribution to Roth IRAs. Also, low-income
taxpayers are allowed the up-to-$1,000 tax credit described
above (under Employee Contributions) for IRA contributions. For
details on Roth IRAs and how they compare to other retirement
IRAs (called traditional IRAs), see the Financial Guide: ROTH
IRAS: How They Work and How To Use Them.
Where to Get Pension Information
The variety of plans and related regulations are numerous. You
should consult with your professional advisors regarding which
options are available to you and which one best first your company’s
needs.
Questions To Ask Before Finalizing a Pension Plan
-
Does the plan require a given level of contribution each
year?
-
Do the plan provisions (eligibility, hours of service and
vesting of employer contributions) meet current and future
needs?
-
What are the costs of establishing and administering a plan
and trust, including providing annual employee reports?
-
What are the investment options offered?
-
Are there any loads (charges) associated with deposits
(front-end charges) or surrenders (rear-end charges) from the
plan?
-
Can — and should — employees make individual investment
selections? What types of reports do participants receive?
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PERQUISITES
While all employees are usually eligible for benefits such as
health and other insurance, retirement plans and leave, key
employees have come to expect certain additional benefits related to
their increased levels of responsibility. Among the perquisites
(perks) employers may want to consider for top performers and key,
or even all, employees are:
-
Company automobile.
-
Extra vacation.
-
Special parking privileges.
-
Personal expense accounts.
-
Spouse travel on company business.
-
Sabbaticals (with pay).
-
Professional memberships.
-
Professional publications.
-
Loans/mortgages.
-
Estate planning.
-
Legal services.
-
Medical expense reimbursement.
-
Physical examinations/health screening.
-
Physical exercise facilities.
-
Executive dining room.
-
Matched donations to universities, colleges and/or
charities.
-
Tuition programs.
-
Dependent day care (on- or off-site).
-
Merchandise discounts.
-
Holiday gifts.
-
Employee assistance programs (EAPs) (substance abuse, debt,
interpersonal relationships, psychological, financial, other
types of counseling).
-
Service awards.
-
Credit unions.
Like basic benefits, perquisites help attract and keep good
employees. You can balance the far higher cost of providing some
perquisites with expectations of increased production from the
employees who benefit.
Key employees responsible for generating contacts for new
business should receive consideration for company automobiles,
personal expense accounts, professional memberships and
publications, club memberships, spouse travel on company business,
credit cards, home entertainment allowances, end-of-year bonuses and
sabbaticals.
Sales staff responsible for keeping current customers satisfied
should receive consideration for company automobiles (if needed for
their duties), credit cards, personal expense accounts, professional
memberships and publications, sales commissions, spouse travel on
company business and end-of-year bonuses.
All employees should receive consideration for EAPs, physical
exercise facilities (if you have them), parking, tuition programs,
dependent day care, holiday gifts, service awards, credit unions,
matched donations to universities, colleges and/or charities,
physical examinations or health screenings when offered and
merchandise discounts.
TIP:
Offer legal services and loans and mortgages on a case-by-case
basis. Some perquisites, such as extra vacation, should be given
only as a reward for extraordinary service to your company.
You may want to consider employer-employee cost sharing of such
pre-requisites as physical exercise facilities, dependent day care,
parking and, perhaps, some health screening services.
Before beginning any program of perquisites, check current tax
law for treatment of each item:
-
Can you, as the employer, deduct it as a business expense?
-
Will it become taxable income for your employee?
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FLEXIBLE COMPENSATION OR "CAFETERIA" PLANS
To accommodate today's many variations in family relationships,
life-styles and values, flexible compensation or "cafeteria" benefit
plans have emerged. In addition to helping meet employee needs,
cafeteria plans also help employers control overall benefit costs.
Cafeteria plans offer employees a minimum level or "core" of
basic benefits. Employees are then able to choose from several
levels of supplemental coverage or different benefit packages. All
packages are of relatively equal value, but can be selected to help
employees achieve personal goals or meet differing needs, such as
health coverage (family, dental, vision), tax reduction (thrift
plans, salary reduction), retirement income (pension plans) or
specialized services (day care, financial planning, legal services).
Careful planning and communication are the keys to the success of
flexible compensation. Employees must fully understand their options
to make choices of greatest benefit to them and their families. Both
employers and employees must fully understand the tax consequences
of the various options.
Keeping Current On Benefit Plans
The government has certain requirements for qualified pension or
profit-sharing plans, as well as for most health and welfare plans.
It is essential for you to stay current on developments that may
affect your plan. Even small changes in tax laws can have a
significant impact on your plan's ability to help you and your
employees achieve your goals. Information on these requirements is
available from the IRS and from qualified accountants and financial
advisors.
Communications
Once you've implemented a benefits program, you'll want to tell
your employees about it. Good communication is important in enabling
employees to use the plan effectively and to appreciate the role of
benefits in their total compensation.
Benefits orientation should be part of the orientation of a new
employee. You can use newsletters, staff memos or employee meetings
with audiovisuals to announce plan changes or answer employees'
questions.
Planning Pointers
Before you implement any benefit plan, you should ask yourself
some questions:
-
How much are you willing to pay for this coverage?
-
What kinds of benefits interest your employees? Do you want
employee input?
-
What do you think a benefits plan should accomplish? Do you
think it is more important to protect your employees from
economic hardship now or in the future?
-
Is a good medical plan more important than a retirement
plan?
-
Do you want to administer the benefits plan, or do you want
the administration done by an insurance carrier?
-
What is your employee group like today? Can you project what
it might look like in the future?
You now have some basic benefits information as well as the basic
questions that need answers before you go benefit shopping for your
employees.
TIP:
If you are serious about offering your employees a satisfactory
benefit plan, the next step may be to contact an insurance broker or
carrier, the local chamber of commerce or trade associations. There
may be off the shelf products that will suit your needs. A benefit
consultant or actuary can help you design a specialized benefit
program.
An adequate benefit program has become essential to today's
successful business, large or small. With careful planning you and
your employees can enjoy good health and retirement protection at a
cost your business can afford.
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*This document is for
information purposes only, and not intended to provide legal or tax
advice.
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