Retirement plans help companies reward and motivate employees. In our view, retirement offerings can be strategically integrated with other reward programs, such as bonuses and profit sharing. They also include flexibility in tailoring contributions if employers maintain a careful balance to avoid pitfalls like differential treatment.
By understanding these elements, employers can create more compelling reward packages that drive satisfaction and loyalty. Doing so creates incentives for strong employee performance while caring for their long-term financial needs.
Retirement plans and bonus programs create a powerful incentive structure when employers combine them. The combination effect can motivate employees by enhancing their overall compensation package in a way that encourages long-term commitment and performance.
Common tools for employers include:
Retirement plans are integral to the employee lifecycle, encompassing Recruitment, Retention, Rewards, and Retirement. Offering these benefits can set employers apart from the competition and become a pivotal factor in a candidate's decision to accept an offer. Doing so also gives companies more choices in how to attract various employees and can appeal to different needs by making retirement a financially viable option for employees as they approach retirement age.
Simply put, a well-designed and communicated retirement plan enables strong business practices.
Each of these plans—profit sharing, ESOPs, and nonqualified plans—offers different advantages and requires careful planning to implement effectively, to align with company goals, and to comply with relevant regulations. When designing and funding these retirement benefits, employers must consider their business goals, employee needs, and regulatory obligations. Many retirement plan service providers can provide input to help support the business planning and regulatory nuances.
Profit Sharing
To implement a profit-sharing plan, employers must first establish a plan document that formally outlines the eligibility criteria, contribution formulas, and distribution methods. These plan documents must be made available to employees. In addition, employers should update them regularly to reflect changes in the law, IRS regulations, and any amendments made to the plan.
Funding a profit-sharing plan requires the employer to set aside the chosen amount from the company's profits for allocation to employees' retirement accounts. Each year, the employer can decide how much to contribute based on the company's financial performance. However, the IRS sets limits on these contributions, typically up to 25% of the total eligible payroll. The IRS also limits contributions, with limits updated each tax year. The annual additions paid to a participant’s account cannot exceed the lesser of 100% of the participant's compensation, or $69,000 ($76,500 including catch-up contributions for employees over 50 years of age) for 2024.1
Incentive stock options programs, employee stock ownership plans, and other stock options
Incentive stock options (ISOs) are stock options offered to employees that can provide favorable tax treatment. Employees can buy company stock at a set price (the grant price) and, if certain conditions are met, pay taxes only on the gains when they sell the stock, potentially benefiting from long-term capital gains rates.
Employee stock ownership plans (ESOPs) are more complex to establish than profit sharing. They require a detailed plan that complies with both ERISA and the Internal Revenue Code.2 Companies set up a trust fund to hold the shares, which employees gradually acquire over time. ESOPs can be used as an employee benefit and a tool for business succession. Companies should consult with legal and accounting professionals to avoid potential missteps. Contributions to ESOPs are tax-deductible, and employees do not pay taxes on the contributions until they receive distributions.
Other options include stock-based compensation plans like restricted stock units (RSUs) and nonqualified stock options (NSOs). RSUs are shares given to employees with conditions, such as continued employment or meeting performance goals. NSOs offer stock options without the favorable tax treatment of ISOs and can be granted to employees, consultants, and directors.
Nonqualified Plans
Nonqualified plans provide additional benefits to executives or key employees. The main difference is that they are not subject to the same regulatory requirements as qualified plans like 401(k)s. To implement a non-qualified plan, the employer must draft and publish a plan document specifying the terms, including the vesting schedule, payout options, and conditions under which benefits are paid.
These plans can include deferred compensation arrangements, supplemental executive retirement plans (SERPs), or other tailored benefits. Unlike qualified plans, contributions to non-qualified plans are not tax-deductible for the employer until the employee receives the benefits. Employees are also taxed on the benefits when they receive them.
Funding for non-qualified plans is flexible. Employers can choose whether to fund them on a pay-as-you-go basis or by setting aside assets in a special trust that remains subject to the company's creditors.
When designing retirement options beyond standard plans for all employees, employers must conduct nondiscrimination testing so that contributions do not disproportionately favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).
If a plan fails any of these tests, the employer must take corrective actions such as refunds or additional contributions to preserve the plan's tax-qualified status. Regulatory deadlines for such actions fall in March of each year (or Month 3 for plans beginning on a date other than January).
Typical tests include:
Nonqualified plans are not subject to the same strict nondiscrimination testing as qualified plans, allowing greater flexibility in designing compensation packages for key employees without the risk of failing compliance requirements. They allow employers to offer additional benefits to executives and other high-level employees while maintaining fair and compliant reward structures for the broader workforce. They can also be tailored to provide additional compensation to executives while maintaining compliance for the broader workforce.
By carefully designing additional retirement offerings to reward employee contributions and align with company goals, employers can create a reward system that boosts engagement, retention, and overall productivity.
1 “Retirement topics - 401(k) and profit-sharing plan contribution limits,” IRS, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits.
2 See “ESOP Fiduciary Rules,” ESOP Association, https://www.esopassociation.org/articles/esop-fiduciary-rules#:~:text=Liability%20For%20Breach,if%20not%20for%20the%20breach. “Employee stock ownership plans (ESOPs),” IRS, https://www.irs.gov/retirement-plans/employee-stock-ownership-plans-esops.
This article is intended to provide general information only and is not intended to provide, and you should not rely on it as providing, legal, accounting or tax advice. Wilmington Trust is not authorized to and does not provide legal, accounting or tax advice. While every effort has been made to correctly summarize legal obligations, you should consult with your own retained attorney and/or professional advisor before acting on any information included in this article, which is not a substitute for you obtaining competent legal advice as to your particular obligations. Facts and views presented in this article have not been reviewed by, and does not reflect information known to, or the recommendations of other business areas of Wilmington Trust or M&T Bank.
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