Funding differences exist between pension plans and profit-sharing plans. If your company is concerned with its ability to continue plan funding , consider a profit-sharing plan. These plans are sometimes referred to as discretionary defined contribution plans. Such benefits would include:

• Plain vanilla profit-sharing plans allowing discretionary contributions each year.
  
• Profit-sharing plans with a 401(k) option.
  
• ESOP plans that invest primarily in the stock of the sponsoring company.
  
• The newer profit-sharing designs such as age-weighted profit sharing and "new comparability" profit sharing.

In the example the maximum deduction for the tax year ending 12/31/93 is $97,500 ($650,000 x 15%). Any contribution made in excess of $97,500 for the plan-year ending 6/30/94 would be deductible in the tax year ending 12/31/94.

In a defined contribution plan the amount or how the contribution is allocated to each participant is defined. The defined benefit plan defines the benefit to be paid at retirement, and plan benefits are based on salary up to $150,000 (subject to annual cost of living adjustments) and age. This type of plan is a true retirement plan and is best suited to the small, closely held business or professional practice to defer income. In many cases defined benefit plans are adopted by very large companies in accordance with union contracts. Because contributions are comparatively high, the defined benefit plan is generally not appropriate for mid-sized companies. To understand the defined benefit plan let's consider an example:

Based on the above data, the plan theoretically will be providing a monthly retirement benefit to Mr. Stockholder of $7,500 ($90,000/12 Months). The plan account must be properly funded to have enough money in 10 years, when Mr. Stockholder reaches age 65, to pay him $7,500 per month for life. Here's where an actuary is needed. Assumptions are made regarding Mr. Stockholder's life expectancy, usually from a published table, and for the interest that the retirement account will need to earn as it pays Mr. Stockholder his $7,500 per month. In the ideal situation, the account will be depleted by the time Mr. Stockholder dies.

Based on these assumptions, the size of the required retirement account or reserve is calculated by asking, "How much money do we need when Mr. Stockholder reaches age 65 to pay him $7,500 per month for x years (his life expectancy) assuming the account will earn y% so that at the end of x years the account is depleted?" This question is the essence of all defined benefit plans.

Although there are many more rules and regulations governing the operation of defined benefit plans, the concept is really as simple as our example. In the example, the retirement account, or reserve, would have to be $979, 112 (using IAM71 mortality table at 5%), and the contribution would be $70,079 (using 6% pre-retirement interest). If the assumptions were different , the contribution also would be different. Although defined benefit plans are more complex to operate, they provide an excellent income deferral mechanism for a very small closely held company or professional organization.

Deductible contributions in a defined benefit plan could easily be more than key persons' salaries when they reach older ages. In certain situations, the tax results are unique. If a sole proprietor establishes a defined benefit plan, monthly retirement benefits can be based on historical compensation from the date the sole proprietor began the business or practice. Depending on the history, it would be possible to design a plan in which the deductible contribution for the current year is equal to the current year compensation (or net schedule C income) so the taxable compensation for that year, after the contribution is made, is zero. Any contribution in excess of the sole proprietor's compensation would not be deductible in that year (but would be in following years) because it is not permissible to create a loss in a sole preprietorship as a result of a pension contribution.

A second application would be in a Subchapter S corporation. A loss is created if the deductible contribution to the pension plan is more than the corporation's profit. This loss is passed through to the stockholders and would have the effect of sheltering other income. Because of the complexities of the defined benefit plan these tax results should be discussed with the tax counsel before any decisions are made.

*ADP is the average deferral percentage required by IRS regulations. In this example the defferal amount for nonhighly compensated employees is the average per employee

**The employer match is the lesser of 25% of the employee's deferral or 2% of salary and is assumed to be 100% vested. The match for the nonhighly compensated employees is the average per employee.

Although the Simplified Employee Pension Plan (SEPP) is not a true retirement plan, subject to the same rules and regulations as the plans discussed, it does have its place in retirement planning. A SEPP is treated as an employer sponsored IRA for tax purposes, with certain alterations. The contribution limits for a SEPP are the lesser of 15% of salary or $30,000 per individual. Unlike the pension and profit-sharing plans that qualify under Code Section 401(a), a SEPPs must cover any employee who has worked three out of the prior five years. There is no differentiation between part-time (less than 1,000 hours) and full-time employees as in Section 401(a) plans.

All contributions made to a Simplified Employee Pension Plan immediately vest at 100% compared to the various graded vesting schedules available for other plans. A SEPP is an IRA, so the participating employee may withdraw the employer contribution as soon as they are made, defeating the purpose of providing retirement income. Generally, withdrawals from a SEPP made prior to age 59-1/2 are subject to a 10% excise tax, under IRC 72(t). SEPPs also may be adopted with a deferral option similar to 401(k) plans, but there are several differences. SAR-SEPP's as they are referred to, only can be used in companies with up to 25 employees. The 401(k) discrimination test (the ADP test) is more restrictive and therefore more difficult and potentially more costly to pass in a SAR-SEPP. Although there are other differences, these are the most important.

The major advantage of SEPPs is their simplicity and low or no cost of administration. There is no cost to prepare the plan because there is no plan document, only an IRS form to execute and form 5500 to file with the IRS. There is no annual. In a company where the only participants are owners or family members of owners, a SEPP is an excellent option. Once a company has to include rank and file employees a Section 401(a) plan is a better option. The savings realized on forfeitures from terminating employees and plan design features, which are not allowed in SEPPs, more than offset any fees the company has to pay to establish and administer a Section 401(a) plan.

What is the "best plan?" There really is no best plan. There is only the plan that is right for you--one that satisfies your company's goals within the cost guidelines you set forth and that your employees perceive as a valuable benefit.