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
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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 employer.
Under the right circumstances, beneficiaries of qualified plan distributors are afforded special tax treatment.
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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.
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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 $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 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.
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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 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.
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401(k)Plans
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 savings.
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Profit-Sharing Plans
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).
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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.