QUALIFIED RETIREMENT PLANS: Greater Contribution Limits, Flexibility Available

By Joseph Joyce

Auto Dealer Advisor, 2005 Spring

Auto dealers today are challenged by an age-old retirement plan dilemma: how to provide maximum benefits to owners and their top-performing managers, yet meet the rigid non-discrimination tests of traditional tax-qualified 401(k) and profit sharing plans. Let’s explore some creative retirement planning ideas that will help you recruit and retain highly qualified people at your dealership.

First, let’s review some of the important benefits of investing in qualified retirement plans to the dealer:

• Contributions by the business are tax-deductible.
• Employee contributions are excluded from current taxable income.
• Contributions grow on a tax-deferred basis.
• Retirement plan assets receive creditor protection.
• You and your employees will have a more secure source of retirement income.
• A properly designed plan will allow you to maximize your contributions and avoid the potential mistake of relying too heavily on the dealership as your source of retirement security.

Next, the passage of EGTRRA (Economic Growth and Tax Relief Reconciliation Act) gives dealers and their employees significantly greater tax-deductible contribution limits and greater flexibility. If a plan is properly designed, there are several of the major benefits of EGTRRA:

• EGTRRA increased the maximum annual addition limit for individual contributions to $41,000 in 2004, and $42,000 in 2005, up to a maximum of 100 percent of the employee’s pay.
• EGTRRA increased the maximum compensation on which contributions can be based to $205,000 in 2004 and $210,000 in 2005, allowing a much greater benefit for owners and key employees.
• EGTRRA increased the employee pre-tax 401(k) deferrals to $13,000 in 2004. The percentage of pay limitation has been removed.
• EGTRRA provides a catch-up provision for workers age 50 and over allowing another $3,000 in 2004.
• The 401(k) pre-tax deferral limits and catch-up amounts will increase $1,000 each year until they reach $15,000 and $5,000 ($20,000 total) in 2006.
• Dealers who have 100 or fewer employees and who have not maintained a plan for the past three years can establish a new plan and receive a 50 percent tax credit up to $1,000 for set-up and maintenance costs for the first three years of the new plan.

Now, let’s explore several of the ways that dealerships can take advantage of these new rules and design plans to benefit themselves and their key employees.

New Comparability Plans group participants into different classes, allowing owners and key managers to receive a larger proportion of the contribution. Dealers and key employees are generally older and closer to retirement. With fewer years to save for retirement, combined with higher compensation, the Internal Revenue Code takes this into consideration, allowing these older owners and key employees to make up for lost time. With the right employer demographics, it’s possible to get 70 percent or more of a profit-sharing contribution allocated to the dealer and key employees (versus a traditional plan where owners and key people often aren’t able to get to the $41,000 maximum due to the discrimination rules).

Safe Harbor 401(k) Plans can be implemented in 2005 for plan sponsors who don’t currently have a plan or if their current plan allows employer contributions only. By doing so, the dealer and key employees can contribute the 401(k) maximum without running afoul of the discrimination rules, thus avoiding refunds of excess contributions at the end of the year. A popular method is the “Safe Harbor Match.” Under this concept, the employer only contributes if an employee contributes to the 401(k) plan. The dealer matches 100 percent up to the first 3 percent of an employee’s deferral, and 50 percent of the next 2 percent (4 percent maximum match). An added advantage of the safe harbor design is that the dealer’s spouse or children working in the dealership can also contribute the maximum amount of $13,000 in 2004. Call your benefit consultant to discuss.

Defined Benefit Plans and the new 412(i) Fully Insured Defined Benefit Plans can be designed to provide even greater tax deductibility for older owners and key employees. Deductible contributions for the 50+ year old dealer can often exceed $200,000 per year. These plans require fairly fixed annual contributions and, depending on the demographics of your dealership, may not work as well.

Non-Qualified Retirement Plans allow the dealer to carve out selected highly compensated key managers on a fully discriminatory basis. The dealer can select who will participate, set the vesting requirements, and decide how the plan will be designed and funded. These “Golden Handcuff” plans are not tax-deductible to the business until the benefits are paid out to the key employee. However, contributions to the plan are not subject to current federal or state income taxes to the selected executive. An experienced benefit consultant should be contacted.