It is quite common for an employer to think in terms of a qualified retirement program when they think of retirement. The benefits of having a company plan would be tax-deductibility, tax deferred, an employee benefit to help attract employees, and a host of other reasons to have one. Most companies should have a long-term retirement plan for their employees. Most accountants will normally jump on this idea because it is another tax deduction.
However, what is rarely discussed are the benefits that the owner of the company receives from the qualified retirement plan! In most cases, the qualified retirement Plan will not be the best choice for the owner of the company, for various reasons.
Here are a few disadvantages for the high-income business owner:
- No control of deposit amounts
- Limited contributions
- Government controlled IRS FILING
- Administration costs- actuarial costs, filing, accounting
- Employer is the fiduciary is having responsibility and accountability to the plan (what happens when the employee loses money in the market?)
- After-tax cost and non-recovery of the net outlay for the company
- The percentage of payout for the employer is usually a much smaller percentage compared to the employees when they retire, so the employer owner is being discriminated against
- The withdrawal is 100% taxable on all the funds
- Tax exposure and penalty for using the funds before 59 ½.
- Forced distribution RMD
- For the employee, having a 401k and/or profit-sharing plan is a great deal. They could have matched contribution’s ability also. It is probably one of the best ways for people to save for their retirement.
- The business owner or highly paid executive has the problem of creating enough capital for retirement so it can produce enough income to narrow the gap between their final pay and retirement needs. In most cases, because of the limits imposed on qualified plans and the taxability of the withdrawals, the qualified plan will not be the answer.
- High Earning Business Owners – it’s a different story!
- However, for the high earning employer, this is not a great deal compared to other executive compensation plans the employer could be. implemented for them. There are several major pension destroyers for the employer when comparing retirement plans vs executive compensation plans.
- Disadvantages of a qualified retirement plan to the “high earning business owner”, compared to using a CEEP!
- Limited contribution amount
- 100% of withdrawal taxable at retirement – With a CEEP you control the contribution amount
- Pre 59 1/2 with penalty.
- Funds in a qualified contribution plan would be very hard to extract (hardship clauses)
- Bottom line, when the employer needs funds to build inventory, buy equipment, payroll, retirement funds are not a source, however, in a private executive compensation plan, they would be.
- With a CEEP you have access to funds without a penalty
- Death benefit; limited to accumulated fund, and taxable in a pension.
- With an executive compensation plan like the CEEP, the death benefits are tax-free and large
- CEEP would have a large tax-free death benefit to finish the retirement that wasn’t even started, and the benefit would be tax-free
- Contribution plans are tax deductible as the contributions are made, consequently showing a charge to earnings in the year of contribution.
- CEEPs are balance sheet friendly as a receivable asset with interest.
- CEEPs can be cost recoverable for the company, while retirement contributions are not. The qualified pension contributions are normally tax-deductible when made, but not recoverable for the company.
- With a qualified plan, you are forced to take RMD (Required minimum distributions)
- With CEEP, you are not. CEEPS distributions are tax-free.
Table below: A qualified contributory plan doesn’t do the job when the owner of a company has an interest in growing wealth through their business. As mentioned, the contribution must be shared with the other employees, and there are rules as to the maximum contribution which high earners can make. In this case, the owner only could put the $30,000 in their account. With the CEEP Executive Compensation plan, the full $50,000 could be deposited into the account of the owner of the company!
|Plan||Contribution||Future Value 66||Gross 15 payout||Taxes YRLY||Net Income|
Many advisors including accountants, lawyers, and financial professionals are not aware of some of the great programs that can be designed using executive compensation. The CEEP program (Corporate Executive Equity Plan) is a flexible design built around the tax code.
Here is a chart comparing a Profit-Sharing Plan/401k and a specially designed CEEP Executive Compensation Plan.
|ITEM||PROFIT SHARING 401K||CEEP|
|Tax deductible||Yes||Yes, optional|
|Tax deferred growth||Yes||Yes|
|Selective as to Participants||No||Yes|
|Pre 59 1/2 availability||No||Yes|
|Tax Free withdrawal||No||Yes|
|Death Benefit||Only current accumulated value of account, taxable||Immediate substantial tax-free benefit|
|Required Minimum Distribution||Yes||No|
Contributory plans like 401k’s, SEPS, simple plans and IRA are wonderful plans for employees to save money for their retirement. However, given the above list of restrictions for employers, they are not effective for high income business owners in my opinion.
Note: I used 30% marginal bracket. Over a 15-year payout, the pension would have a $361,560 tax liability, while the CEEP was tax free.
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