We are now in the process of updating all of our clients’ qualified plans. Plan restatements are required because of tax law changes over the past several years. The deadline for some plan updates has passed, but for most plans the deadline is September 30, 2003.

Before you automatically sign the new documents from your plan provider, think twice. The new version of your old plan may not be your best choice, and it may even be an outright mistake.

The type of plan the employer used in the past may be entirely unsatisfactory for the future. The new rules on contribution and deduction limits, and the new opportunities in plan design features, may make the prior plan a mismatch. Furthermore, the administrative costs of some types of plans have gone up dramatically. Before an employer simply gives the go ahead to restating the existing plan, someone should see if that old shoe still fits. It is easier and much less expensive to restate using the right plan now rather than learn next year that you made a mistake.

Background The tax law changes have increased the amount of money that can be contributed to qualified plans. Profit sharing plans and SEP contributions are increased from 15% to 25% up to $40,000. SIMPLE IRAs in 2003 will permit employee deferrals of $8,000 plus the employer contribution. 401(k) plans will accommodate employee elective deferrals of $12,000 in 2003. Those over age 50 can make extra "catch up" 401(k) deferrals of $2,000 and $1,000 in SIMPLE IRAs. For all plans the compensation limit for calculating contributions is increased to $200,000. These increases from prior law make the plan selection entirely different.

Let’s review the features of the most common plans and see the circumstances where they are suited.

SEPs The simplified employee pension plan, or SEP, is a favorite of mine. Technically speaking, a SEP is not a qualified plan. It is an aggregation of employer-funded IRAs for each participant. SEPs are funded by the employer at rates up to 25% of the first $200,000 of compensation. SEPs must cover all employees who have worked in any 3 of the immediately preceding 5 years. The employer is permitted to require fewer than 3 years in the "3 out of 5" criteria. A SEP is an "employer pay all" arrangement. Contributions are always 100% vested.

The SEP files no 5500s, there is no fiduciary obligation of the employer, and there are no administrative costs. The SEP is a good fit for employers of ten people or less, and the fewer the employees the better. The SEP is an excellent first time retirement plan for small employers. I have never had a client regret using a SEP.

SIMPLE IRAs This is a 401(k) plan with training wheels. Employees may defer up to $8,000 of their pay and the employer contributes either a 3% match or 2% of pay. This must be the only plan offered by the employer. The plan is always 100% vested. Assets are held in IRAs. The plan must cover employees who have earned $5,000 in any two prior years and expect to earn that amount in the year of contribution.

With the SIMPLE IRA, there are no 5500s, no fiduciary obligation, and minimal administrative costs, if any. Small employers who are interested in 401(k) plans (because employees put in their own money) should start with a SIMPLE IRA for a year to two.

One Person 401(k) Plan The one-person 401(k) is the new kid on the block. For the sole proprietor or one-person corporation, this can work better than the SEP or SIMPLE IRA. In a one-person 401(k), the first $12,000 of compensation can be contributed as an elective deferral. Then, profit sharing contributions can be made in addition. And, if the owner’s spouse is an employee, you can double up on contributions. Ain’t love grand?

When the shoe fits, the one-person 401(k) is terrific. The administrative costs are insignificant. The financial services industry has fine packages to make these plans easy to set up and run.

Profit Sharing Plans The basic profit sharing plan is the Chevy of the retirement world. It has always been a great plan and is now better. Maximum contributions have been increased from 15% to 25%. Vesting schedules are permitted. Employer contributions are discretionary.

As good as they are, profit sharing plans are not for every employer. Profit sharing plans require annual maintenance. Most employers pay for outside help to take care of plan administration, such as employee enrollment, distributions, 5500 preparation, and the like. These costs are significant and rising.

Small employers with profit sharing plans should be made aware of less expensive choices, such as the SEP, the SIMPLE IRA, or the one-person 401(k).

Larger employers with profit sharing plans should consider converting to a 401(k) plan, and perhaps a safe harbor 401(k). Adding the 401(k) elective deferral opportunity to an existing profit sharing plan does not cost all that much more in administration, and the added features will be appreciated by the employees. Employers are switching to 401(k)s to reduce the contributions they make annually.

Money Purchase Pension Plans Let’s play "Jeopardy!" The answer is: Eight-track tapes, platform shoes, vinyl records, coonskin caps, Calypso music, day trading, and money purchase pension plans. The question is: What are some things that are over?

The only reason to have a money purchase pension plan is to get a 25% contribution. In the old days, 10% money purchase plans would be genetically linked to a 15% profit sharing plan to leverage a 25% contribution. Profit sharing plans and SEPS can now have 25% contributions. All money purchase pension plans should be terminated. Any questions?

One Person Defined Benefit Plans The defined benefit plan is back, but in the "DB Lite" format.

The defined benefit plan, the true pension plan, became virtually extinct for small employers in the mid-1980’s. But, the DB plan has been resurrected as an attractive choice in one-person businesses with the right profile: the owner is over 45, makes a lot of money, is expected to make a lot of money in the future, and has no employees. In these circumstances, the one-person DB plan works great. Reason: the owner can put away a lot more than $40,000 per year. It is the ultimate "catch up" plan for older people who haven’t saved much for retirement.

Exotic Plans This is my term for age-weighted plans, ESOPs, new comparability plans, and target benefit plans. Each of these is highly specialized and is designed to work in unique circumstances. These plans are generally expensive to set up and maintain. Most employers do not understand them and are entirely dependent upon an attorney, actuary, or outside administrator. Exotic plans are like expensive Italian sports cars---you have to adopt an Italian sports car mechanic to make them work.

Employers with one of these exotic plans should look hard during the restatement process to see if the plan still fits the company’s needs.

Plans for the Tax Exempt Tax exempt employers have a wide choice of qualified plans. They can use almost any type of plan already mentioned (but not the ESOP), plus the 403(b) plan.

For many tax exempt employers, the choice comes down to the 401(k) plan or a 403(b) plan, as these both accommodate employee elective deferrals. In most cases I prefer the 403(b) plan, especially if the employer is going to put in minimal or no contributions (which is the case with most cash-strapped tax exempts). The 403(b) is not subject the ADP non-discrimination tests for employee elective deferrals. The savings in administrative expenses and overall simplicity is very attractive.

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