When business owners establish a 401(k) or profit-sharing plan, one of the first questions they usually ask is: “How much can I put away?”
I understand.
The tax deduction and retirement contribution are often major reasons they established the plan in the first place.
But designing a retirement plan solely around maximizing the owner’s contribution is like buying a car based entirely on how fast it can go without asking what it costs or whether you can actually drive it.
There is more to plan design than the owner’s contribution.
You have employees.
Coverage testing matters. Nondiscrimination testing matters. Eligibility matters. Employer contribution costs matter. Safe harbor contributions may matter.
I’ve seen plan designs that look fantastic on paper because the owner can receive a substantial contribution. Then the employer discovers what they have to contribute for everyone else.
Suddenly, that fantastic plan design isn’t so fantastic.
Good plan design requires understanding the entire workforce. That includes compensation, ages, ownership, job classifications, turnover, related businesses, and the employer’s objectives.
It also requires looking beyond this year.
Maybe the demographics work perfectly today. What happens when you hire ten employees next year? What happens when another owner joins? What happens when you acquire another company?
A retirement plan should be designed around the business, not simply around one owner’s desired contribution.
That’s why plan design should involve conversations between the employer, TPA, financial advisor, accountant, and ERISA counsel when necessary.
There is nothing wrong with wanting to maximize the owner’s contribution. That’s often one of the biggest benefits of sponsoring a retirement plan.
Just remember that the owner isn’t the only participant in the plan.
Sometimes the most important number isn’t how much the owner can contribute.
It’s what getting that contribution is going to cost everyone else.
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