Not many have heard of a Davis Bacon Retirement Plan, but for many retirement plan sponsors and advisors, it may help enhance and even improve retirement savings programs. To appreciate the benefits and advantages of a Davis Bacon Retirement plan, it’s helpful to understand its history.
What’s In the Name The Davis Bacon Act (the Act or prevailing wage act) was named after its authors- a Pennsylvania Senator James Davis and a New York Representative Robert Bacon. It was passed amid the Great Depression in response to the plea of local workers who were frequently and systematically displaced by lower paid out-of-state migrant workforce as contractors fiercely competed to win public projects. In addition to federal statute, over time 32 states have passed their own version of the prevailing wage law.
What Davis Bacon Act Requires The Act requires that contractors and subcontractors hired for federal construction projects pay to their workers wages equal to the local wages paid for similar private projects. This wage is known as a prevailing wage.
Who It Affects The requirements of the Act apply to companies with contracts involving federal government for construction, alteration, improvement of public buildings or works, e.g. highways, roads, bridges, airports, landscaping, sewers, power stations, etc. The prevailing wage requirements apply to ‘laborers and mechanics,’ i.e. individuals whose job duties are manual and physical in nature. Supervisors, clerical, and professional employees are generally exempt.
How It Works The prevailing wage is set by the Department of Labor (DOL); it varies by location, year, nature of project, and the types of workers. It has two components, the hourly pay rate- typically paid to the employee- and the hourly fringe benefit which can be paid to the worker in cash or contributed for eligible fringe benefits. For example, the DOL may determine that a local prevailing wage for a given project and occupation is $35 per hour; a contractor may comply with this requirement by paying $35 as cash wages, or $25 in cash wages and $10 in fringe benefits, or $23 in cash wages and $12 as a fringe benefit.
What is an Eligible Fringe Benefit? The Act lays out specific requirements for the types of fringe benefits which may be used as eligible prevailing wage pay. They include health, vision, dental, life insurance, contributions to health reimbursement accounts, and retirement plans such as 401(k), profit sharing, and pension plans, including defined benefit and cash balance plans.
Why Using Fringe Benefit to Fund a Retirement Plan Pays Off When the fringe benefit is paid as compensation, it is subject to all relevant employer payroll taxes and burdens, which may range from 14% to 25% (e.g. Social Security tax, Medicare tax, Federal Unemployment Tax, State Unemployment Tax, Public Liability Insurance, Workers Compensation).
Since retirement accounts are among the eligible fringe benefits, all or a part of the prevailing wage’s fringe component may be used to fund a company retirement plan. Plans designed to receive such contributions are known as Davis Bacon or a Prevailing Wage retirement plans. Neither employer nor employees are required to pay payroll taxes on fringe benefits deposited to the plan. Here’s an example for a company that has 30 employees working on a Davis Bacon project with a prevailing wage of $35: $25 hourly wage and a $10 fringe benefit.
By directing the fringe benefit, or its portion, to fund a retirement plan instead of paying it as a taxable wage, the company is able to recognize substantial payroll tax savings. There’s a benefit to employees as well: they will never have to pay their portion of social security and Medicare tax (7.65%) either since retirement plan distributions are exempt from payroll tax:
- Number of employees 30
- Annual hours on a Davis Bacon Project per employee 1100
- Davis Bacon fringe benefit per hour $10
- Total Davis Bacon fringe benefit amount $330,000
- Employer payroll tax savings at 14.45%* $47,685
* FICA/Medicare; FUTA; SUI; Liability Insurance; Workers Compensation
We’ll talk about strategic deployment of Davis Bacon Fringe Benefits in Part 2 – Making Davis Bacon Contributions Do More.
This communication is purely for informational purposes and to provide information of general interest. It is not intended to constitute legal or tax advice and should not be treated as such. Use of Davis Bacon contributions in a retirement plan may not be appropriate in every situation or for every retirement plan. For tax or legal advice, please consult an appropriate legal or tax advisor.