A Beginner’s Guide to Retirement Plans for Businesses
Setting up a qualified retirement plan for your business can have many benefits. These plans typically offer several tax advantages, such as a deduction for your contributions and tax deferred growth on your investments, which can be an effective way for you to save for retirement through your company. A work retirement plan also gives your employees another fringe benefit so that you can keep them happy and reduce turnover.
A number of different retirement plans are available for businesses, with each having different rules, restrictions, and benefits. If you’re going to spend the time and money to set up a plan, it’s important to find the one that’s the right match for your needs. Shown below is a review of five of the most popular retirement plans for businesses today.
The Simple IRA
One of the easiest and least expensive plans to set up is the Simple IRA, which was designed for small companies. It’s generally a good choice for businesses with 10 or fewer employees, but you can also use this plan as long as you have no more than 100 employees. These plans are also relatively easy to maintain because you don’t need to file regular updates with the IRS, and you don’t need to hire an administrator to monitor your plan.
With the Simple IRA, you and your employees who are younger than 50 can defer up to 100 percent of your salaries into the plan up to a maximum of $12,000. Anyone 50 or older can defer up to $14,500. While your employees are not required to make contributions each year, there are contribution requirements for you as the employer. When you set up the plan, you can choose between either matching each employee’s annual contributions up to 3 percent of their salary or automatically adding 2 percent of each employee’s salary to their accounts regardless of whether they contribute or not.
The SEP IRA
The Simplified Employee Pension IRA is similar to the Simple IRA. These plans are also easy and inexpensive to set up and have minimal filing and administration requirements. The SEP is also a good fit for small businesses, and there is no limit to the number of employees you can have with this type of plan.
The main advantage of a SEP over a Simple IRA is that you have more control over when you can contribute to the plan for your employees. Contributions are not mandatory each year. If your business income is a bit unpredictable, not having this requirement can help you manage costs. Your employees also can’t contribute to the plan.
Whatever percentage you do contribute, however, needs to be the same for every employee enrolled in the plan. If you want to contribute 10 percent of your salary to your account, you need to give all participating employees 10 percent of their salaries as well. In comparison, the most you would need to give another employee with the Simple IRA is 3 percent of an employee’s salary.
You can contribute up to 25 percent of your compensation up to a maximum of $51,000 a year, as of 2013. You can contribute a higher percentage of your salary with the Simple IRA, but you can contribute more money per year with the SEP if your compensation is high enough.
Profit Sharing Plan
If you’re looking for a way to motivate your employees to work harder with their retirement benefits, the profit sharing plan could be a good option. With this plan, you contribute a certain amount of your company’s profits to your retirement plan and the retirement plan of your employees.
Profit sharing plans can be customized a bit more to better fit the needs of your business. You have more control in determining how profits are distributed to employees throughout the company, unlike the SEP and Simple IRA, which have specific payment rules. In exchange for this greater control, a profit sharing plan is typically more expensive to set up and run. You need to hire an administrator to properly design the plan and then submit a Form 5500 to the IRS each year to prove your plan is compliant.
A profit sharing plan also gives you control over when you make contributions to yourself and the employees. If you’ve had a bad year and don’t want to make a contribution, you don’t have to. Even if you don’t make a profit for the year, you can still make contributions. How you distribute payouts with your profit sharing plan depends on the plan’s formula, though the most you can give to each employee is 25 percent of their salary up to a maximum of $51,000, as of 2013.
If your company is larger, a 401(k) could be another good choice. Typically, a 401(k) plan makes sense if you have more than 10 employees because these plans have relatively higher setup and administration costs. In exchange, you have more control over how you manage the benefits and payments to your employees.
You can set up your 401(k) plan to accept both contributions from your employees and/or contributions from you on their behalf. You have some control in determining the formula for how much you will give each employee, for example, saying you will match each employee’s contributions up to a percentage of their salaries.
If you are worried about employee turnover, you can also set up your 401(k) plan with a vesting schedule, which indicates how long an employee would need to stay at your company to keep your matching contributions. For example, you could set up your plan so that an employee who leaves without working three years wouldn’t be able to keep any of your matching contributions. After three years, that money would belong to them.
While you have some control over your 401(k) plan, the IRS requires that it follow several guidelines to make sure the retirement plan isn’t just benefiting highly compensated employees. Accordingly, these plans can be expensive to run. You need to file this paperwork each year, and you will likely need an outside administrator to make sure your plan is compliant.
One way around this issue is to set up your 401(k) plan as a safe harbor 401(k) plan. In this case, you need to make a minimum number of payments to your employees each year, and their matching contributions are then automatically vested; an employee doesn’t lose anything by leaving early. In exchange, the IRS filing requirements are much more lenient.
Defined Benefit Plan
One other option is a defined benefit plan, also known as a traditional pension plan. With this plan, instead of just giving your employees money each year to invest for the future, you are promising to give them a set payout at retirement. You set up your defined benefit plan with a formula that determines how much an employee will get at retirement. This amount is based on such factors as how long the employee worked at your company and how much the employee earned on average each year.
Defined benefit plans are the most expensive plans to set up and administer. They can also be very expensive to fund, as you could need to pay some employees a very large amount of money when they retire. On the other hand, defined benefit plans also give you the chance to put away large amounts of money for your own retirement. There is no set contribution limit to the amount you can add to your pension fund each year; you need to set aside the appropriate amount to fund your promised retirement payments. Your plan administrator calculates how much you need to put aside each year.
If you don’t have very many employees and/or your employees have not been at the company long and don’t earn as much as you do, your defined benefit formula gives you the chance to put away a large amount of money for your retirement without spending an excessive amount on your employees. Doing this works well if you started saving late and need to catch up.
As you can see, you need to consider a lot of information for your work retirement plan. Picking the right plan for your company isn’t an easy decision to make on your own. Working with a qualified retirement specialist can be quite helpful in your search. This expert can give you a full review of all the pros and cons of these plans and make sure you understand all the options available for your business. For more information on retirement plans, contact one of the Senior Wealth Advisors at R.W. Rogé & Company today.