Business owners want to maximize profits now and put money away for when they retire. They also want to attract and retain great employees. Retirement benefit plans can help business owners to accomplish both of these objectives. And they help employees by creating a “forced savings” and offer significant tax deferral benefits.
There are many retirement plan options out there. So which retirement plan is the right one for your company? It depends on many factors, including the current size of your business, and may change as your company grows. Below is a discussion of three common retirement plan options.
1. As the name suggests, a Simplified Employee Pension (SEP) plan allows employers a simplified way to set aside money in retirement accounts for themselves and their employees. It is a good option for small, closely-held companies with few employees. Under a SEP, employers can contribute up to 25 percent of each employee’s pay to traditional IRAs (SEP-IRAs) set up for employees. Employers can decide annually if and how much to contribute. Employees can not contribute to traditional SEP plans and the funds are immediately vested. Contributions made by the employer are tax-deductible and the investments grow on a tax deferred basis. In addition, businesses may be eligible for up to $500 in tax credits per year for each of the first three years of a new plan. A business of any size, even self-employed individuals, can establish a SEP without the paperwork or start-up and operating costs of a conventional retirement plan.
2. A traditional 401(k) profit sharing plan may be the most common retirement plan for mid-size companies. It allows an employer to attract and retain quality employees by offering them a more competitive compensation package while also offering tax benefits to the owners and the business. A 401(k) plan allows employees to electively defer a portion of their salary before it is taxed or, in the case of Roth 401(k)s, after taxes. Employees have flexibility in determining how much of their pre-tax income to contribute (up to certain limits) and typically can choose how those funds are invested, giving them the opportunity to design an investment strategy to meet their current cash-flow and future retirement goals. Employers can choose to contribute a percentage of each eligible employee’s salary. These plans require more administration and coordination than SEPs, and limit the amount of deferral for highly compensated employees, but are typically a good option as companies grow.
3. Defined Benefit plans allow company owners to maximize retirement plan contributions. These plans are less flexible than standard profit sharing plans but allow the company to contribute greater amounts and potentially allocate a larger portion of the contribution to higher compensated employees. For example, Cash Balance Plans are defined benefit plans which are currently popular with businesses that have highly paid employees who wish to make large contributions on an annual basis. Unlike some 401(k) and all SEP plans, defined benefit plans can be subject to a vesting schedule, and they tend to be complicated and more costly to administer.
While there are a number of benefits associated with adopting a retirement plan there are also many rules and regulations that need to be followed, so be sure you have experienced consultants assisting with plan choice, adoption and reporting.
Call or email Kevin Hedrick, WBL’s tax planning and compliance partner, today to discuss your company’s benefit plan options.