|According to The Pension & Welfare Benefits
Administration, small businesses employ nearly 40% of the private-sector
workforce in the United States. However, a majority of small businesses do not
offer their workers retirement savings benefits.
If you’re like many other small business owners in the
United States, you may be considering the various retirement plan options
available for your company. Employer-sponsored retirement plans have become a
key component for retirement savings. They are also an increasingly important
tool for attracting and retaining the high-quality employees you need to compete
in today’s competitive environment.
Besides helping employees save for the future, however,
instituting a retirement plan can provide you, as the employer, with benefits
that enable you to make the most of your business’s assets. Such benefits
- Tax-deferred growth on earnings within the
- Current tax savings on individual
contributions to the plan
- Immediate tax deductions for employer
- Easy to establish and maintain
- Low-cost benefit with a highly-perceived
value by your employees
Types of Plans
Most private sector retirement plans are either defined
benefit plans or defined contribution plans. Defined benefit plans are designed
to provide a desired retirement benefit for each participant. This type of plan
can allow for a rapid accumulation of assets over a short period of time. The
required contribution is actuarially determined each year, based on factors such
as age, years of employment, the desired retirement benefit, and the value of
plan assets. Contributions are generally required each year and can vary widely.
A defined contribution plan, on the other hand, does not
promise a specific amount of benefit at retirement. In these plans, employees or
their employer (or both) contribute to employees’ individual accounts under the
plan, sometimes at a set rate (such as 5 percent of salary annually). A 401(k)
plan is one type of defined contribution plan. Other types of defined
contribution plans include profit-sharing plans, money purchase plans, and
employee stock ownership plans.
Small businesses may choose to offer a defined benefit
plan or any of these defined contribution plans. Many financial institutions and
pension practitioners make available both defined benefit and defined
contribution “prototype” plans that have been pre approved by the IRS. When such
a plan meets the requirements of the tax code it is said to be qualified
and will receive four significant tax benefits.
- The income generated by the plan assets is not subject
to income tax, because the income is earned and managed within the framework
of a tax-exempt trust.
- An employer is entitled to a current tax deduction for
contributions to the plan.
- The plan participants (the employees or their
beneficiaries) do not have to pay income tax on the amounts contributed on
their behalf until the year the funds are distributed to them by the
- Under the right circumstances, beneficiaries of
qualified plan distributors are afforded special tax treatment.
It is necessary to note that all retirement plans have important tax, business
and other implications for employers and employees. Therefore, you should
discuss any retirement savings plan that you consider implementing with your
accountant or other financial advisor.
Here’s a brief look at some plans that can help you and your employees save.
SIMPLE: Savings Incentive Match Plans for Employees of
A SIMPLE plan allows employees to contribute a percentage
of their salary each paycheck and to have their employer match their
contribution. Under SIMPLE plans, employees can set aside up to $10,000 each
year by payroll deduction. If the employee is 50 or older then they may
contribute an additional $2,500. Employers can either match employee
contributions dollar for dollar – up to 3 percent of an employees wage – or make
a fixed contribution of 2 percent of pay for all eligible employees instead of a
SIMPLE plans are easy to set up – you fill out a short
form, administrative costs are low, and much of the paperwork is done by the
financial institution that handles the SIMPLE plan accounts. Employers may
choose either to permit employees to select the IRA to which their contributions
will be sent, or to send contributions for all employees to one financial
institution. Employees are 100% vested in contributions, get to decide how and
where the money will be invested, and keep their IRA accounts even when they
SEPs: Simplified Employee Pensions
A SEP allows employers to set up a type of individual
retirement account – known as a SEP-IRA – for themselves and their employees.
Employers must contribute a uniform percentage of pay for each employee.
Employer contributions are limited to the lesser of 25 percent of an employee’s
annual salary or $44,000. (Note: this amount is indexed for inflation and will
vary). SEPs can be started by most employers, including those that are
SEPs have low start-up and operating costs and can be
established using a single quarter-page form. Businesses are not locked into
making contributions every year. You can decide how much to put into a SEP each
year – offering you some flexibility when business conditions vary.
401(k) plans have become a widely accepted savings vehicle
for small businesses. Today, an estimated 25 million American workers are
enrolled in 401(k) plans that hold total assets of about $1 trillion.
A 401(k) Plan allows employees to contribute a portion of
their own incomes toward their retirement. The employee contributions, not to
exceed $15,000, reduce a participant's pay before income taxes, so that pre-tax
dollars are invested. If the employee is 50 or older then they may contribute
another $5,000. Employers may offer to match a certain percentage of the
employees' contribution, increasing participation in the plan.
While more complex, 401(k) plans offer higher contribution
limits than SIMPLE plans and IRAs, allowing employees to accumulate greater
Employers also may make profit-sharing contributions to a
plan that are unrelated to any amounts an employee chooses to contribute.
Profit-sharing Plans are well suited for businesses with uncertain or
fluctuating profits. In addition to the flexibility in deciding the amounts of
the contributions, a Profit-Sharing Plan can include options such as service
requirements, vesting schedules and plan loans that are not available under SEPs.
Contributions may range from 0% to 25% of eligible
employees' compensation, to a maximum of $44,000 per employee. The contribution
in any one year cannot exceed 25% of the total compensation of the employees
participating in the plan. Contributions need not be the same percentage for all
employees. Key employees may actually get as much as 25%, while others may get
as little as 3%. A plan may combine these profit-sharing contributions with
401(k) contributions (and matching contributions).
Your Goals for a Retirement Plan
Business owners set up retirement plans for different
reasons. Why are you considering one? Do you want to:
- Take advantage of the tax breaks, to save
more money than you’d otherwise be able to?
- Provide competitive benefits in addition to –
or in lieu of – high pay to employees?
- Primarily save for your own retirement?
You might say "all of the above." Small employers who want
to set up retirement plans generally fall into one of two groups. The first
group includes those who want to set up a retirement plan primarily because they
want to create a tax-advantage savings vehicle for themselves and thus want to
allocate the greatest possible part of the contribution to the owners. The
second group includes those who just want a low-cost, simple retirement plan for
If there were one plan that was most efficient in doing
all these things, there wouldn’t be so many choices. That’s why it’s so
important to know what your goal is. Each type of plan has different advantages
and disadvantages, and you can’t really pick the best ones unless you know what
your real purpose is in offering a plan. Once you have an idea of what your
motives are, you’re in a better position to weigh the alternatives and make the
right pension choice.
If you do decide that you want to offer a retirement plan,
you are definitely going to need some professional advice and guidance. Pension
rules are complex, and the tax aspects of retirement plans can also be
confusing. Make sure you confer with your accountant before deciding which plan
is right for you and your employees.