In this second article, I’ll focus on the employer / employee side of tax qualified and tax advantaged retirement plans. A key component often missing in retirement preparation is understanding the savings tools available, and how they work for you. Many confusing acronyms as well as multiple number designations exist in employer sponsored plans, most of which are Federal tax driven; SEP IRA, SIMPLE, 401(k), Roth 401(k), Solo 401(k), 403(b), 457, etc. These designations are all short abbreviations for parts of the tax code. The bottom line of each of these Federal tax programs, similar to individual taxpayer programs, is that the Government wants you to save toward your retirement, to supplement your Social Security, and uses tax favored savings plans as an incentive.

These Federal tax advantaged plans must generally treat all employees similarly and stipulate maximum funding guidelines. They are similar to and in a number of cases driven off the individual taxpayer IRA; Individual Retirement Account. There are two major classes of these qualified employer retirement plans, Defined Benefit and Defined Contribution.

Defined Benefit (DB) plans are paid for fully by the employer, with the benefit formula being fixed or “defined”. Examples of DB plans are traditional pensions and SEPs. In these type pension plans, the employer usually makes all the contributions based on a formula which must be consistent for all employees. The employee usually makes no contribution.

Traditional pensions typically base their benefit formula on each employee’s service years, age, and compensation. These plans have been historically utilized by large companies with consistent cash-flow and a stable work force. However, because the plans are typically expensive and difficult to maintain due to the detailed employee records and substantial administration involved in governmental reporting requirements, they have become less popular. Additionally, the employer carries all the investment risk.

Simplified Employee Pension (SEPs) are the small employer’s easy answer to a company paid retirement plan. Typically the employer makes contributions to a SEP IRA, established for each employee. A common formula would pay 2-3% of an employee’s contribution into the employee’s SEP IRA. The law allows funding up to 25% of total compensation for all employees, up to a maximum of $43,000 per individual for 2006. Additional detailed rules exist, so be sure to check with an advisor for your specific situation. Benefits of a SEP for a small employer include; ease of establishment, portability of benefits for employees, investment risk borne by employee, and some flexibility in funding during a poor year. Disadvantages are; it can be expensive to include part time employees, the owner is tied to the same funding formula, and it is usually inadequate as a sole retirement vehicle.

Defined Contribution (DC) plans are the other major tax qualified retirement plan sponsored by the employer. In this type plan, the employee’s input triggers the employer’s contribution, whose funding level is defined by the type of plan. These plans are popular with employees because the employee controls funding and investment decisions, and get regular statements thus better appreciating the employer match. The plans are popular with employers as they are typically only obligated to fund an account if the employee makes the financial commitment. There are three primary DC plan types; SIMPLE, 401(k), and 403(b).

SIMPLE IRA plans, or Savings Incentive Match Plan for Employees, are designed to use either employee salary reduction contributions, which are matched by the employer, or non-elective contributions by the employer alone. The employer contribution is either a dollar for dollar match on the first 3% of compensation that the individual elects to defer, or a 2% of compensation nonelective contribution for all eligible employees. Contributions are made into an employee’s SIMPLE IRA. All employees, including part time who earn over $5,000, must be included. The maximum an employee may defer for 2006 is $10,000, plus an additional $2,500 catch up if they are age 50 plus. Other rules apply so check with your advisor. Advantages to a SIMPLE plan are; ease of administration, limited employer obligation until the employee contributes, employee borne investment risk, and for self employed individuals, a higher tax deductible amount than an IRA. Disadvantages include; all employees over $5,000 must be included, the owner is tied to the same funding as other employees, and, most importantly, the $10,000 contribution limit is lower than other employer plans.

401(k) plans, which pertain to a section of the federal tax code, are very popular for all sizes of employers due to the shortcomings of the plans described above. A 401(k) is funded by employee payroll deferrals and usually matched at some level by the employer. The employee elects to have a portion of regular wages deferred into a third party trustee account. Employee limits for 2006 are $15,000 plus an additional $5,000 catch up for aged 50 plus participants. The employer may elect to contribute a matching portion, typically 2-6% of compensation. These plans can be set up to exclude part time and short term employees. The plan can allow for loans to employees of their holdings without forfeiture penalties, a provision many employees appreciate.

There are several 401(k) plans that coincide with the different types of employers. The traditional 401(k) plan is geared toward larger employers, as the plan is more expensive to implement and administer. These plans allow for the employer to withhold matches in poor years and can be configured to benefit higher compensated employees. In 2006, a Roth 401(k) was introduced offering the same provisions as a traditional 401(k), but funded with after-tax employee dollars and not taxed upon withdrawal.

A Safe Harbor 401(k) eliminates much of the annual reporting of the traditional 401(k) and is less expensive to implement. For many small business owners, it is the most popular retirement plan. However, it requires a minimum employer match each year of between 2 – 3% of employee compensation.

A Solo 401(k) is especially designed for self proprietor businesses and husband and wife companies. It can work well for contractors and realtors. Similar funding levels of the $15,000 plus $5,000 catch up for the employee plus the employer match make it one of the best tax-advantaged saving plans available. Loan provisions can also be incorporated.

Two other plans are available for non-profit and governmental organizations. The 403(b) plan is similar to the 401(k), but is designed for tax-exempt and public schools, and a 457 plan is designed specifically for government and non-church control organizations that are tax-exempt. Most provisions, including employer contributions and employee deferrals, are similar to the 401(k) with some existing differences.

The most important consideration for any of these plans is to save to your maximum!