Page 181 - Essentials of Payroll: Management and Accounting

ESSENTIALS of Payr oll: Management and Accounting
• Profit sharing plan. Contributions to this type of plan are
intended to be funded from company profits, which is an
incentive for employees to extend their efforts to ensure that
profits will occur. However, many employers will make con-
tributions to the plan even in the absence of profits. This plan
is frequently linked to a 401(k) plan, so that participants can
also make contributions to the plan.

Defined Benefit Plan. This plan itemizes a specific dollar amount
that participants will receive, based on a set of rules that typically com-
bine the number of years of employment and wages paid over the time
period that each employee has worked for the company. An additional

factor may be the age of the participant at the time of retirement.
Funds received by participants in a steady income stream are taxed at
ordinary income tax rates and cannot be rolled over into an IRA, whereas
a lump-sum payment can be. This type of plan is not favorable to the
company, which guarantees the fixed payments made to retirees, and so
bears the risk of unfavorable investment returns that may require addi-
tional payments into the plan in order to meet the fixed payment obli-
gations. Some of the more common defined benefit plans are as follows:
• Cash balance plan. The employer contributes a pay credit (usu-
ally based on a proportion of that person’s annual compensa-
tion) and an interest credit (usually linked to a publicly avail-
able interest rate index or well-known high-grade investment
such as a U.S. government security) to each participant’s
account within the plan. Changes in plan value based on these
credits do not impact the fixed benefit amounts to which par-
ticipants are entitled.
• Target benefit plan. Under this approach, the employer makes
annual contributions into the plan based on the actuarial
assumption at that time regarding the amount of funding
needed to achieve a targeted benefit level (hence the name of

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