Retirement Plan Options For Small Businesses
Author: Ron Leyva
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So, you have gone into business for yourself…Way to go. But you want to put a retirement plan in place for you employees, but don’t know what you can do. Here are some options that might be in interest to you. This article is a bit long, but I hope that it provides you with some information that can make take some worry off your mind.
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 include:
• Tax-deferred growth on earnings within the plan
• Current tax savings on individual contributions to the plan
• Immediate tax deductions for employer contributions
• 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.
1. 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.
2. An employer is entitled to a current tax deduction for contributions to the plan.
3. 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 employer.
4. 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 Small Employers
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 ,500 in 2009 (,500 in 2008) by payroll deduction. If the employee is 50 or older then they may contribute an additional ,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 matching contribution.
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 change jobs.
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 ,000 in 2009 (,000 in 2008. This amount is indexed for inflation and will vary each year). SEPs can be started by most employers, including those that are self-employed.
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 trillion.
A 401(k) Plan allows employees to contribute a portion of their own incomes toward their retirement. The employee contributions, not to exceed ,500 in 2009 (,500 in 2008), 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 ,500 in 2009 (,000 and 2008). 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 savings.
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 ,000 in 2009 (,000 in 2008) 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 setup 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 employees.
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.
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Retirement Plan Options For Small Businesses
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How Business Owners Plan For Retirement
Saving for retirement is even more important for solo-entrepreneurs because you don’t have a company sponsored pension plan or matching 401K contributions to rely on. There are many retirement plans available to self employed individuals and small businesses. Which one is right for you?
Here is just a sample of the retirement plans available to solo-preneurs and small businesses:
Roth IRA – although this is not just for solo-preneurs, this is the first place you should look to save if you are just starting to save for retirement (or resuming to save after starting a business). Roth IRAs are low-cost, very flexible, and allow you to grow money tax-free as long as you follow the distribution rules. Contributions can be made up to ,000, and can be withdrawn at any time without tax or penalty (earnings withdrawn may be subject to penalty and tax if withdrawn before age 59 1/2 and certain other conditions are not met).
SEP IRA – if you’re maxing out your Roth IRA, and are ready to save more, a SEP IRA allows you to save up to 25% of your compensation (20% of your self-employment income) for a maximum of ,000 per year. Contributions are tax-deductible, and SEP IRAs have low maintenance fees. Contributions can be made for employees also, but employees cannot contribute to their own SEP IRA. This is a good choice if you just have a handful of employees and are looking for a low-cost way to save for your own and your employees’ retirement.
Simple IRA – a Simple plan offers many of the benefits of a 401K, but with less IRS reporting requirements. You can contribute up to ,000 to a Simple IRA, with an employer match of up to 3%. Contributions are tax-deductible, and Simple IRAs also enjoy low annual fees. Employees are allowed to contribute to Simple plans, and a company match is mandatory. If you have a lower salary (or self-employment income) in your small business, a Simple IRA allows you to put more away towards your retirement than other plans.
Solo 401K – for small businesses with no employees, the solo-401K allows you to put the maximum amount away, with less cost and less reporting requirements than a traditional 401K. Similar to a SEP IRA, contributions max out at ,000. However, unlike a SEP IRA, participants in a Solo-401K can contribute up to 100% of the first ,000 of compensation or self-employment income, and an additional amount up to 25% of your compensation. This is important because it allows you to save substantially more than a SEP IRA, if your compensation is less than 0,000 per year. A solo-401K is not appropriate for small business with employees or expecting to add employees.
There’s no one best plan for all small businesses. The best plan for you will depend on many factors, such as whether you have employees or not, how much you want to contribute each year, how much time you want to spend administering the plan, etc. To get more information about small business retirement plans, contact a no-load mutual fund company, a discount brokerage company or a fee-only financial planner.
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Small Business Pension Plan Options
Whenever advertising or articles regarding pension plans are mentioned, they are usually ignored by small business owners and the self-employed. Small businesses are often under the impression that pension plans are only for large corporations and do not apply to them. However, by ignoring these messages they are missing the opportunity to take advantage of the benefits that pension plans have to offer.
Businesses that offer this type of fringe benefit increase job satisfaction among their employees which can often result in a decrease in staff turnover. Another benefit pension plans can provide significant tax deductions for business owners and deferred earnings for employees.
Nowadays there are an abundance of plans and options to choose from. Many plans are very convenient to implement and require very little paperwork. So, there is no time like the present to implement a retirement plan for you and your employees.
In order to choose the plan that fits your company’s needs, you must begin with a sound understanding of what your options are. There are pros and cons to every plan so each should be carefully considered. To assist you in making the right decision for your company, below is an overview of the current and most common plans:
The 401(k) Plan
A 401(k) plan is a retirement plan sponsored by employers. With this type of plan, employees may choose to have a portion of their salary deferred to any of the 401(k) investment choices that have been selected by the employer. The employer may also contribute to the employee’s 401(k) by matching a portion of the investment. The benefit of a 401(k) is that employees are not taxed on the contributions they or their employers make until they withdraw from the plan. Another benefit is that accumulated earnings on the account are tax-deferred as well.
A 401 (k) can be more complicated to establish and maintain then other types of plans and there are annual IRS reporting requirements associated with it as well. Also, the law requires that if low compensated employees do not contribute enough by the end of the plan year, then the limit is changed for highly compensated employees.
There are individual 401 (k) plans that can be set up by a company (incorporated or unincorporated), in which the owner is the sole proprietor and/or only employee. The key advantage to plans such as these is that they permit larger contributions than other plans. The individual 401(k) also tends to be a little less complicated than the traditional 401(k).
Simplified Employee Pension (SEP) Plan
Often referred to as a SEP-IRA, this is essentially a retirement plan set up by a small business employer or by a self-employed person. This pension plan allows employers to contribute to SEP-IRA plans on behalf of their employees in an amount greater than traditional IRA limitations. The main advantages of the SEP-IRA to the employer is that the administrative burdens are few, the plan is simple to install, and it does not have the start-up and operating costs of conventional retirement plans.
Because you decide the amount to be contributed each year to SEPs, this plan can offer a great deal of flexibility. However, they can only be funded through employer contributions and annual contributions are limited to 25 percent of each employee’s pay. Another benefit of SEPs in contrast to other plans is that you can establish it up to the extended due date of your tax return.
Savings Incentive Match Plan for Employees (SIMPLE)
The SIMPLE plan gives small businesses an affordable way to offer retirement benefits through employee salary reductions and matching contributions similar to the SEP. A SIMPLE plan is available to yourself and eligible employees and is made up of individual retirement accounts (IRAs). A SIMPLE plan can also be set up as a 401(k) plan. Both of these types of SIMPLE plans can be established easily using a “model” plan document which is available from the IRS. With a SIMPLE plan, employers offer matching contributions equal to employee contributions or fixed contributions equal to a percent of employee wages.
Requirements and limitations for the SIMPLE plan dictate that employers must have fewer than 100 employees and must generally be established before October 1st of the calendar year. Employers that currently sponsor another retirement plan generally cannot sponsor a SIMPLE plan.
The Keogh (H.R. 10) Plan
A Keogh (or HR 10) plan is a tax-deferred retirement savings plan for self-employed individuals and their employees. Most self employed individuals who have earned income from self-employment are eligible under this plan.
Keogh plans have gained popularity in recent years thanks to tax legislation that has made it possible for contributions made to Keogh plans equal to that of plans held by large corporation. Outlined below are the two key types of Keoghs:
1. Defined contribution plans: These plans come in a few different forms such as target benefit plans, money purchase plans, and profit sharing plans. Each plan requires contributions that are based on either a percentage of an employee’s wages or percent of an owner’s profits. The amount the contributions have accumulated by retirement will dictate what benefits the participants will receive when they retire.
2. Defined benefit plans: Plans such as these have a set amount of retirement benefit that the plan will pay out upon retirement and contributions made are based upon the payout amount. Any benefit that a participant will receives upon retiring is limited by law and requires actuarial calculations to determine the amount of annual contribution needed.
One major drawback to all Keogh plans is that the reporting requirements are more complicated than the SEP and SIMPLE-IRA plans. Another disadvantage is that a business owner is required to make contributions for eligible employees and therefore cannot only cover themselves.
Contributions can be made to Keogh plans up to the company’s tax return due date (extensions included). However, they must be established no later than December 31st of the tax year that you will begin taking a deduction for contributions.
Ted Lanzaro, CPA “The Millionaire Tax Advisor” owns and operates Lanzaro CPA, LLC, a tax strategy, accounting and business advisory firm with offices in Shelton, CT. The firm concentrates on providing advisory services, education and products design to promote business development, tax savings and wealth creation. He can be reached by phone at 203-924-5760 or via email at Ted@lanzarocpa.com. You can subscribe to “The Millionaire Tax Advisor” Newsletter at www.millionairetaxadvisor.com. You can also get a copy of Ted’s special report “10 Proven, Totally Legal and Effective Tax Strategies That Will Put Thousands In Your Pocket Every Year” at his website www.lanzarocpa.com.
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