Why you should consider special pay retirement plans
Are you struggling to manage the costs of your employees cashing out unused sick leave and vacation time? If so, a special pay retirement plan may help you reduce your annual budget and increase pre-tax retirement savings for your employees’.
What is a special pay plan?
A special pay plan is another way of handling special forms of compensation, other than regular salary or wages that your employees earn. Instead of an employee receiving these funds as compensation, it would be a non-elective contribution to their retirement plan.1 In other words, you could deposit accrued sick leave into your employees' retirement plan as an employer contribution, instead of allowing your employee to choose how it's distributed.
What are the benefits to the employee?
This option could help employees save money in the long run. Sometimes when employees choose to cash out and receive these funds, it may push them into a higher tax bracket making them pay an increased tax rate and taking home less income. With a special pay plan, the employee will not have to pay state or federal income tax until the funds are withdrawn from the plan. This may allow the funds to experience greater interest accumulations and compounding.
What are the benefits for the employer?
A special pay plan allows your organization to save on certain taxes. You could see a Federal Insurance Contributions Act (FICA) tax savings of 7.65% and you may save on state payroll tax as well. These contributions do not have to be made in one lump-sum contribution either, allowing you to ease budget burdens by stretching them for as long as five years.
Consider this hypothetical example:
You have 10 employees retiring this year with a total of $100,000 of unused sick leave or vacation pay. If you didn’t have a special pay plan, you would have to pay them a lump sum plus 7.65% in FICA tax for a total of $107,650 which could negatively affect your current budget. The employees would also owe income tax on their portion, potentially at a higher tax bracket.
If you had a special pay plan, you save $7,650 in FICA tax, and you could stretch the $100,000 burden over five years. Your employees also benefit by not having to pay income tax until they withdraw those funds from their retirement account.
What should you know about a special pay plan?
For a special pay plan to qualify, you must choose a tax qualified retirement plan, like a 403(b) plan. Also, the contributions must be a mandatory payment into your employees’ retirement plan. There are a few scenarios where the employer contribution may not be considered non-elective and, therefore, would not qualify for the benefits. This may include situations where the employee can opt out of the contribution and take the funds as compensation instead, or the plan states an employee must reach a pre-determined number of hours or dollar amount to receive the contribution.
Create a plan that fits your needs
Your special pay plan can be customized to meet your needs. You can create your own criteria for who should be eligible for the benefit and whether you use this as a one-time contribution to motivate a group to retire early or as an on-going part of your retirement plan provided to all employees.
If you decide a special pay plan is right for you, make sure all the details are communicated in all agreements, like contracts, employee handbooks, etc. These details should define who’s eligible, how they can enroll, how and when payments will be made, and what will happen if the employee passes during the scheduled distributions.
If you need help creating your retirement plan offering, you can speak with your local American Fidelity account manager.
This blog is up to date as of July 2022 and has not been updated for changes in the law, administration or current events.
