04/09/2012 05:39 pm ET | Updated Jun 09, 2012

Are Your Retirement Benefits Providing Maximum Advantage?

Don't look now, but higher taxes on high-income earners may be on the way.

The Bush tax cuts, which were extended in 2010, will expire on Dec. 31 unless Congress and President Obama act to extend them further. The cuts' expiration would effectively mean a significant hike in the federal income tax rate and the capital-gains rate for investments.
What's more, President Obama has recently been ratcheting up election-year pressure on Congress by calling for increased taxes on millionaires.

It's impossible to predict how events in Washington play out, of course. But if you're concerned about the impact of potentially higher taxes on the highest earners within your company, a review of your retirement plans may be in order. It's very possible that adjustments can be made to help soften any blow that may be coming.

Possible adjustments range from tweaking existing plans to adding new plans outright. In the minor tweak category: adding a Roth option to your defined-contribution plan.

Unlike traditional 401(k) contributions, which are made on a pretax basis, Roth 401(k) contributions require participants to pay taxes up-front on their contributions. The Roth approach makes sense for participants who believe that their tax rate is likely to be higher when they retire than it is now.

Another benefit of contributing to a Roth 401(k): Investment proceeds within the fund are not taxed, as long as the account is established for at least five years, and participants take distributions at the proper age.

If your retirement plan provides for a profit sharing contribution, a helpful tweak can be applied to the profit sharing allocation formula.

In 2012 the Social Security Administration only taxes the first $110,100 of an employee's annual income for Social Security benefit purposes. Thus, those earning $200,000, $400,000 or $500,000, say, receive a smaller proportion of their earnings in Social Security benefits than do their lower-paid coworkers.

Employers can help compensate for that disadvantage by directing more of their total profit sharing contribution to higher-paid employees. One of the more straightforward ways to do so is by adopting what are known as integrated allocation formulas. Such formulas can enable higher profit sharing contributions to top executives by taking their relative Social Security contributions into account.

Another adjustment, meanwhile, can clear the way for a company's highest-paid employees to maximize their own 401(k) contributions. In certain cases, non-discrimination rules mean such employees can only contribute a portion of the full dollar limit (currently $17,000, as well as a $5,500 "catch-up" contribution for participants age 50 or older).

One solution to this dilemma: Safe-Harbor 401(k) plans, which are exempt from the non-discrimination rules. The catch is that firms offering such plans must provide a minimum level of contributions for their lower-paid employees. One alternative calls for a contribution of 3 percent of employees' wages. Another drawback is that these mandatory employer contributions must vest immediately, meaning employees are entitled to the full employer contribution amount right away.

The good news: If an employer is already making the required minimum contribution to lower-paid employees' accounts, adding the Safe Harbor provision is a relatively simple matter.

Another solution for directing more of the company's profit sharing contribution to the higher paid employees is to adopt what's known as a new comparability allocation formula. Doing so can allow firms to skew more contributions toward their older, and presumably higher-paid, personnel than is possible using the integrated allocation formulas. To qualify, employers must offer minimum contributions to lower-paid employees and conduct additional non-discrimination testing. Whether this test can be passed depends heavily on the age of the higher-paid individuals vs. the age of the general staff.

Meanwhile, employers looking for ways to significantly bolster the tax deferred benefits they offer their top executives might consider the more ambitious step of adopting additional retirement plans.

Cash-balance plans, for instance, are a powerful way to shelter money for a firm's top executives. They allow higher paid employees to receive employer contributions in excess of the IRS' annual profit sharing plan contribution limit of $50,000. Of course, adopting a whole new plan is a significant undertaking. It comes with a host of requirements, including providing minimum benefits to lower-paid employees and minimum required contributions calculated by an actuary.

Likewise, firms can adopt what are known as non-qualified plans. Such plans can allow executives to defer income over and above the limit for a 401(k) plan. And they allow employers to make discretionary contributions. For example, based on business conditions, an employer could opt to put $100,000 into an executive's non-qualified plan.

Non-qualified plans do come with significant caveats. One of the biggest: Contributions are not sheltered from creditors -- meaning the money could disappear if the company fails.

Clearly, the various options for improving retirement-saving benefits carry very real costs and obligations. On the other hand, offering more robust benefits can make a significant impact on top executives' current and future finances. And that may be especially valuable if higher taxes are indeed on the horizon.

The first step is to seek advice from those in the profession. These topics are complicated. However, with guidance from a knowledgeable employee benefit consultant the picture becomes clear. A consultant can review your current plan design and help you determine what the optimum retirement program is for your company.