Retirement Plan Design for a 22-Employee Contractor
Ron, 54, owns 100% of a commercial electrical contractor with 22 employees and $1.6 million of annual payroll. Four employees, including Ron, are owners or family members and are highly compensated. Average staff pay is $48,000; turnover is 25%; three employees earn more than $150,000. Ron earns $300,000 and wants to put away $120,000 per year for retirement. The company currently sponsors a SIMPLE IRA with a 3% match, and Ron contributes the maximum deferral plus the match. Cash flow is seasonal but the company has $700,000 in cash and no debt. Ron is considering a safe harbor 401(k) with a 4% match and a new comparability profit sharing feature, or a cash balance plan paired with a 401(k). He wants to keep total employee cost below $100,000 per year and does not want a plan that requires a long commitment if revenue falls.
1. Estimate the maximum owner contribution under the current SIMPLE, a safe harbor 401(k)/profit sharing plan, and a cash balance combo. What employee costs are likely?
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Under the SIMPLE, Ron can defer the maximum plus catch-up and receive a 3% match. Using current limits, that is roughly $16,500 + $3,500 + 3% of $300,000 = about $29,000. That is far below his $120,000 goal.
A safe harbor 401(k) with a 4% match and new comparability profit sharing can get Ron to the §415(c) annual additions limit, roughly $70,000, plus the age-50 catch-up, for about $77,500. The 4% match costs 4% of $1.6 million, or $64,000. To reach the §415(c) limit, Ron needs about $34,500 of profit sharing. If his profit sharing rate is about 11.5% of $300,000, the gateway for staff is generally the lesser of one-third of the highest HCE rate or 5%, so staff may need about 3% to 5% of pay in profit sharing. Combined with the match, staff cost could be roughly $112,000 to $144,000, which is above the $100,000 target.
A cash balance plan can add a large deductible contribution for Ron, but it also requires meaningful staff contributions and actuarial administration. A combined cash balance and 401(k) design could approach or exceed $120,000 for Ron, but employee cost could easily exceed $150,000 and the plan requires ongoing funding. Given seasonal cash flow, the safer path is a safe harbor 401(k)/profit sharing design at a lower owner contribution, with a cash balance plan added later if revenue is stable.
2. How do top-heavy, ADP/ACP, gateway, and vesting rules affect the design?
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A safe harbor 401(k) that consists only of deferrals and safe harbor contributions is generally exempt from top-heavy rules. Once Ron adds profit sharing, the plan is no longer solely safe harbor, and top-heavy minimum contributions apply. The 3% top-heavy minimum for non-key employees can be satisfied by the safe harbor contribution, but it must be coordinated with the gateway and the profit sharing allocation.
ADP and ACP testing are avoided if the plan satisfies the safe harbor requirements, including the required notice and the 4% match or 3% nonelective contribution. The profit sharing allocation still must satisfy the general test under §401(a)(4). New comparability allows age-weighted allocations, but each non-highly compensated employee must receive a gateway allocation of at least the lesser of one-third of the highest HCE allocation rate or 5% of compensation.
Vesting matters for cost control. Safe harbor nonelective contributions must be 100% vested; safe harbor match must be fully vested. Profit sharing can use a six-year graded or three-year cliff schedule, and a cash balance plan typically uses a three-year cliff. With 25% turnover, vesting can reduce long-term cost, but it does not reduce the first-year funding requirement. The design should use immediate vesting where required and avoid promising benefits the company cannot fund in a slow year.
3. What implementation and fiduciary steps should Ron take before adopting the new design?
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First, confirm that the SIMPLE IRA can be terminated effective before the new 401(k) plan year begins; the company cannot maintain both plans for the same year for the same employees. Provide required employee notices and coordinate the transition with payroll.
Next, adopt a written plan document, an investment policy statement, and a documented committee process. Compare recordkeeping, actuarial, and advisory fees, and disclose them to participants. If auto-enrollment is added, choose a qualified default investment and give the required notice. For the cash balance plan, obtain an actuarial illustration of minimum and maximum contributions, funding flexibility, and PBGC or non-PBGC coverage. Review the plan's fidelity bond and fiduciary insurance.
Finally, model a downside scenario: what happens if revenue falls 20% and the company must reduce or freeze contributions? A safe harbor 401(k) can be amended prospectively for the next year, but a cash balance plan has ongoing minimum funding requirements. Given the seasonal business, phase in the cash balance plan only after the 401(k) has run for a full year and cash flow has been stress-tested.