Designing the Right Retirement Plan

We believe that our experience with small, mid-sized, and large companies is without rival. This is evident in the number of plans that we handle, as well as the importance and complexity of these plans. Our experience includes:

Defined Benefit Plans, including:

Defined benefit (DB) plans define the retirement benefit that is ultimately paid to a participant. Typically, a participant will accrue a benefit (usually a fixed percent of compensation, or fixed dollar amount) for each year of credited service. The total benefit accruals at a participant’s retirement date can then be paid out in the form of an annuity (such as a single life or joint and 50% survivor annuity). In lieu of an annuity, a participant can elect to receive an actuarially equivalent single sum benefit.

An Employer is required to fund a DB plan each year with contributions in accordance with minimum funding standards. The contribution is not allocated to individual participant accounts. Instead, an unallocated or pooled account is set up to pay retirement benefits when due. The amount required each year is determined by an enrolled actuary. The Employer bears the investment risk in a DB plan. Favorable investment experience will reduce future Employer contributions, whereas adverse investment experience will increase future Employer contributions.

Tax deductible contributions to a DB plan can range from the amount required to satisfy minimum funding standards up to the maximum amount which corresponds to the plan’s unfunded current liability, as determined by an enrolled actuary.

Traditional Defined Benefit Plan
A defined benefit plan promises to pay a specified benefit at future retirement to eligible participants, in contrast to a defined contribution plan that allocates a specified contribution to its participants’ accounts at a present time. The actual amount of the participant’s benefit in a defined benefit plan is described by a formula stated in the plan document, and the employer as plan sponsor assumes the investment risk by agreeing to pay the calculated benefit to the participant upon attainment of the retirement age under the plan. Therefore, if plan assets earn less than expected, the employer will make a larger contribution to ensure that the plan has sufficient monies to pay the promised benefits. Should the plan’s investments earn more than anticipated, the employer’s costs will decrease. All contribution requirements in this plan type are made from the employer, employee contributions are not allowed.

Cash Balance Plan
A cash balance plan is a type of defined benefit plan that contains hypothetical account balances communicated to participants. A participant will earn what is called a contribution credit (usually a fixed percentage of compensation or a fixed dollar amount) for each year of service he/she is credited with. The participant will also earn what is called an interest credit (usually a fixed interest rate or a variable rate of interest based on an index value) for each year of service he/she is credited with. The benefit in this type of plan is easier to understand for most participants than a traditional cash balance plan plus the participant can easily track the growth of their cash balance account each year. All contributions in this plan type are made from the employer and the assets are invested as one pooled account. There are no individual account balances.

Fully Insured Plan (412(i))
These plans, formerly defined under IRC412(i), may offer a good alternative to the traditional defined benefit plan for small employers with very few, if any, rank & file employees, who want to maximize tax deductible contributions.
Such a plan is funded exclusively with annuity contracts, and possible with life insurance policies, issued by a common life insurance carrier. Hence, the name fully insured. The underlying interest rates on these contracts and policies are guaranteed, but are more conservative and typically lower than in a traditional defined benefit plan. This allows for a larger tax deductible contribution under the fully insured plan.
The fully insured plan can work especially well for a small employer with several partners. Each partner will have their own annuity contract and possibly a life insurance policy. The partners will not have to share a portion of the pooled assets under a traditional defined benefit plan.
Added features of the fully insured plan are as follows:

  • No enrolled actuary certification is required,
  • No required quarterly contributions and interest charges,
  • No full funding limitation, and
  • Administrative costs are generally less

There are certainly some disadvantages. The plan’s entire investment portfolio is locked in with very conservative insurance contracts. And participant loans are not available.

Combo Plans

Combo Plans
One way to maximize benefits to key personnel and also maximize the key personnel’s share of the company’s total retirement plans contributions is referred to as a defined benefit/defined contribution (DB/DC) combo plan. The defined benefit plan is typically a cash balance plan and it is not unusual to limit the number of employees eligible for the cash balance plan to the absolute minimum required under the law.  The profit-sharing  and 401(k) plan generally uses a 3% of compensation non-elective safe harbor design to ensure that the key employees can defer the maximum into the 401(k) plan without worrying about getting a  refund.  They usually  require a contribution of up to 7.5% of compensation for non-highly compensated employees (“NHCEs”) in the profit-sharing and 401(k) plan.  Therefore, the 3% of salary non-elective contribution is coupled with a profit-sharing contribution equal to 4% of compensation.  The contribution of up to 7.5% of salary generally opens the door to much greater contributions to the key employees, thus paying for itself.  The cash balance portion of the combo plan is usually where the key employees receive most of their contributions and those contributions can be quite high, sometimes approaching $150,000 for each key employee.


Combo Plan designs work extremely well for successful smaller professional service firms (law firms, medical and dental practices, etc.) where the older principals want to save more for retirement and lower their current income taxes.  They also work well in successful businesses that have a track record solid earnings.

Defined Contribution Plans, including:

Defined contribution (DC) plans, also known as individual account plans, define the contribution a participant receives under the plan. The Employer contributions are allocated to individual accounts maintained for each participant within the plan. The total contributions plus total investment earnings of the participant’s account is the participant’s retirement benefit from the plan.

The participant bears the investment risk in a DC plan. There is no guaranteed amount paid to the participant. Investment results are not guaranteed, and do not affect the Employer’s cost of funding contributions to the plan.

The contributions made by Employers to a DC plan can be allocated to participants’ accounts under different types of allocation formulas, as described below:

  1. The simplest formula is salary ratio, in which each participant receives the same contribution as a percent of compensation. This type of formula satisfies IRS safe harbor rules, which means that the contribution allocations automatically satisfy IRS nondiscrimination requirements.
  2. Another IRS safe harbor allocation formula is permitted disparity (or integrated). Such a formula provides an additional allocation of up to 5.7% of excess compensation to each participant with excess compensation. Excess compensation is typically defined to be any compensation in excess of the Social Security Taxable Wage Base.
  3. Cross-tested allocation formulas do not satisfy IRS safe harbor rules. Instead, they must be general-tested each year, in accordance with IRS nondiscrimination test requirements.Under a cross-tested formula different rates of contribution can be allocated among different groups of eligible employees. Given the right demographics, cross-tested allocation formulas can provide key employees with substantially greater contribution leveraging than any of the IRS safe harbor allocation formulas.

A profit sharing plan is a type of DC plan, whereby contributions each year are subject to the discretion of the Employer. The Employer contribution each year can range anywhere from zero, up to the maximum tax deductible amount of 25% of eligible payroll.

A 401(k) plan is a type of profit sharing plan, whereby each eligible employee is permitted to make contributions on a pre-tax basis.

401(k) plans
One of the most popular types of pension plans today is the 401(k) Plan. More and more plan sponsors are recognizing the role 401(k) plans can play in meeting employees’ retirement needs. A 401(k) plan is a type of Defined Contribution Retirement Plan that enables employees to make contributions to the plan before taxes. Contributions made to the plan reduce the employees’ taxable income while saving for retirement. Contributions and earnings thereon are not taxed until they are withdrawn from the plan. The maximum elective deferral limit is adjusted annually for cost of living increases.

A 401(k) plan may accept designed ROTH contributions as well. This is another option employees can use to save for their retirement. ROTH contributions are elective deferrals that are made on an after-tax basis. The earnings generated by these ROTH contributions may be tax-free when distributed if certain criteria exist. These contributions are subject to the same limit as the pretax elective deferrals described in the paragraph above. The ROTH contribution plus the pre-tax elective deferrals can’t exceed the maximum elective deferral annual limit.

A special note regarding these plan types is that administration on them is needed and annual discrimination testing must be completed. Discrimination testing is done to ensure that the plan is not discriminating in favor of the highly compensated employees. An annual test is completed to make sure that those highly compensated employees are not benefiting in a manner that isn’t fair to the non-highly compensated employees. For example, an employee that makes $100,000 might be able to defer the maximum deferral of $17,000 but another employee that makes only $20,000 might not be able to defer as much. This testing finds a way to even out the deferral abilities among the entire staff and if the test fails, those highly compensation employees have to take a partial refund of the deferral to even the playing field. The deferral that is returned to the employee will then become taxable income along with the earnings it made while in the plan. This evens everything out, thus the plan will pass its discrimination testing for the year.

Within the 401(k) plan, employer contributions are allowed in the form of matching contributions, profit sharing contributions and safe harbor contributions. Full details on these employer contributions within the 401(k) plan can be found by contacting a member of our consulting staff.

Profit Sharing Plans enable an Employer to make a contribution to the plan in order to reward employees for their efforts. The employer can exercise discretion over the amount contributed to the plan each year and need not base the contribution on actual profits. The employer may also decide in a certain year not to make an employer profit sharing contribution. Profit sharing contributions can be made in a variety of ways, a percent of compensation, a flat dollar amount, and the contribution may or may not be integrated with social security. The contribution maybe also be cross-tested. This concept is described in more detail under “cross tested/new comparability” but the basic concept of this contribution method is to enable the employer to maximize the benefit to the highly compensated employees while still being able to pass certain testing requirements.

A 403(b) Plan, also referred to as a “tax sheltered annuity plan”, is a type of Defined Contribution Pension Plan available only to employees of public schools and charitable organizations (non-exempt organizations), which enables such employees to make contributions to the plan before taxes. Contributions made to the plan reduce the employees’ taxable income while saving for retirement. Contributions and earnings thereon are not taxed until they are withdrawn from the plan. Employer contributions can also be made in a 403(b) arrangement, in the form of either a matching contribution or a profit sharing contribution. There have been many regulatory changes over the last seven or so years and the administration of these plans have become more complex with stricter filing requirements.

401(k) Safe Harbor Plans
A 401(k) safe harbor plan is similar to the traditional 401(k) plan but the employer is required to make a fully vested contribution to each employee. In return for this mandatory contribution, the company gets a free pass on a discrimination test called the ADP. The attraction for an employer is if they have low participation in the 401(k) plan, they are still able to maximize their own contributions by making a safe harbor employer contribution to all participants without worrying about the discrimination testing. The employees are receiving an employer contribution that is fully vested so it is attractive for them as well. This plan type isn’t for every employer, as passing discrimination tests aren’t always an issue, but it does serve a great purpose for some.

Cross-tested / New Comparability
A cross-tested new comparability plan is a type of profit sharing plan which allows the Employer to maximize the benefit of highly compensated employees while having the plan remain in compliance with IRS regulations. IRS regulations allow the employer to divide the plan participants into two or more classes of employees. Many times, larger contributions can be made for one class, versus another, depending on the age of the employees within the group. The regulations provide for a method of projecting the contribution and equating it to a benefit at retirement age. Discrimination tests are performed to show that the benefits provided to the highly compensated employees are “comparable” to the benefits provided to the non-highly compensated employees, and therefore, the plan and its contributions are nondiscriminatory. This type of plan is not a good fit for all companies, so please contact us to see if this is right for you and your firm.


Services, Compliance, and Expert Knowledge

vector image of businessmen holding barsMadison Pension Services’ expertise in pensions extends to all aspects of the industry: actuarial calculations, retirement plan design, consulting services, and compliance.

It is not enough to design a plan; it must comply with the highest standards at every phase of development and maintenance.
It is not enough to maintain a plan; we must constantly monitor developments to make sure your plan always fits your needs.


Our advantages:

Problem Solving
Innovative Design

Our experience and expertise includes all forms of qualified and non-qualified retirement plans, including various types of defined benefit plans, defined contribution plans such as 401(k) plans, 403(b) plans, profit sharing plans, ESOPs, cross-tested plans and plans with a Roth 401(k) component.

Throughout the consultant-client process, Madison Pension Services will ensure that your plan is fully compliant and meets your needs.

We strive to provide the highest-quality services (see our Testimonials), intricate plan design (see our Case Studies), and informative communication (see our Client Newsletters).

Investment Advisory Services & Fiduciary Oversight

Fiduciary oversight programs manage protection to trustees and help ensure excellence in plan management. Best practice recommendations are made and processes put in place for flawless execution.