SAVINGS PLANS | Profit-Sharing and Similar Plans

Almost any qualified plan can have a provision for employee contributions to supplement the plan fund or benefit. A plan that is designed particularly to exploit the possibility of employee contributions is often referred to as a savings plan or thrift plan. The term savings plan will be used here to describe a plan featuring employee after-tax contributions.

Design of Savings Plans

A savings plan is a defined-contribution plan so that employees can have separate accounts. Usually, qualified savings plans are designed as profit-sharing plans (rather than money-purchase pension plans) because only a profit-sharing plan permits account withdrawals during employment, and this is an important feature of the plan if the plan is to be described to employees as a savings medium. Thus, a savings plan can generally be described as a contributory profit-sharing plan.

The typical savings plan features employee contributions matched by the employer. Plan participation is voluntary; employees elect to contribute a chosen percentage of their compensation up to a maximum percentage specified in the plan. The employer then makes a matching contribution to the plan. The matching may be dollar for dollar, or the employer may put in some multiple or submultiple of the employee contribution rate. For example, typically a plan might permit an employee to contribute annually any whole percentage of compensation from 1 to 6 percent. The plan might then provide that the employer contributes at the rate of half the chosen employee percentage; thus, if the employee elects to contribute 4 percent of compensation, the employer would contribute an additional 2 percent.

If the plan's maximum contribution level is too high, there is a possibility of discrimination because only higher-paid employees could be in a position to contribute to the plan, and only they would receive full employer matching contributions. To prevent this type of discrimination, there is a specific numerical test applicable to after-tax employee contributions. Under this test [Code Section 401(m)], a plan is not deemed discriminatory for a plan year if, for highly compensated employees, the total of employee contributions (both matched and voluntary) plus employer matching contributions does not exceed certain numerical limits similar to those applicable to Section 401(k) plans. Administration of the Section 401(m) limits can be complex and costly.

Apart from the features relating to employee contributions, savings plans generally follow the rules for profit-sharing plans described earlier. In designing a savings plan, emphasis is usually put on features relating to the objective of providing a savings medium for employees. Thus, a savings plan usually has generous provisions for vesting, employee withdrawal of funds, plan loans, and investment flexibility.

Advantages and Disadvantages of Savings Plans

Savings plans have been very popular in the past and continue to be so, despite the advent of other types of plans, such as Section 401(k) plans, that provide greater tax leverage. Some older savings plans have been converted to add a 401(k) feature while retaining the provision for additional after-tax contributions by employees. Like all qualified plans, a savings plan provides a tax-deferred savings medium because earnings in the plan fund are not taxable until the employee's account is distributed.

A savings plan usually does not maximize the potential tax deduction available for plan contributions, because it involves after-tax contributions by the employee—contributions that are not deducted or excluded for federal income or Social Security tax purposes. A greater degree of tax deductibility can be provided with other types of plans, such as regular profit-sharing plans or Section 401(k) plans. However, some of these plans may require a greater employer outlay for the plan itself (although not necessarily for the overall compensation package). These other plans may also entail greater restrictions on the funds, which may make them a less attractive savings medium from the employee's standpoint.