Providing a retirement plan for your business can be beneficial to both you as an owner and your employees. With the move away from pension plans many individuals will be relying more heavily on their own savings to provide income during retirement. One of the best tools we have to create retirement savings is a plan through their employer.
If you are considering creating a retirement plan for your small business you have several options. Below will be a discussion about a few of those options. This is not an exhaustive list and there may be some plan types that will benefit you more than another. Prior to implementing a plan you should consult with a knowageable professional (financial advisor and tax advisor) who can help you select the plan that will best fit your small business. The contribution limits and tax deductions can vary from plan to plan and year to year. So, it is advised to work with a trusted advisor.
SEP IRA- The Simplified Employee Pension IRA or (SEP IRA) for short is a nonqualified retirement plan that your small business can implement to put money back for retirement. This plan is 100% funded by you the Employer and the contributions are immediately vested in the account. Employees do not make contributions into it and if they separate service for any reason the employee will retain all of the funds in their SEP accounts. The benefit to the employer is that they are not required to make a contribution on an annual basis. So if you have varying cash flows from year to year this may be a plan worth considering. These plans are easy to establish and require little work to maintain.
Simple IRA- If you are looking for a plan that will allow employee and employer contributions the Simple IRA should be considered. This plan will allow employees to contribute up to a certain dollar amount (see plan limits set by IRS) and will require the employer to contribute either a match of at least 3% of the employee contributions or 2% of employee’s salary. Remember the Simple IRA gives immediate vesting to employees. This is also a low cost plan to maintain and easy to establish.
Traditional 401K- The traditional 401K is a qualified plan and will be required to preform and meet testing requirements each year so it is a more expensive plan to establish and maintain. However, it will allow both employee and employer contributions. Also, unlike the SEP and Simple IRAs the 401k plan can be established with a vesting schedule determined by the employer. This plan will give you the small business owner the greatest amount of flexibility regarding vesting and matching contributions.
There are also additional types of 410ks that a small business can establish to help reduce the annual testing requirements such as a Safe Harbor 401k and an Automatic enrollment 401k. The Safe Harbor makes employer contributions a requirement, which will eliminate the need for nondiscrimination testing. An Automatic enrollment 401k will automatically enroll employees. Then the employee can adjust their contribution amount or opt out of the plan. This will eliminate the nondiscrimination-testing requirement as well. While these plans will reduce the amount of required annual plan testing they will not eliminate all testing requirements.
Roth Plans- Roth plans can be used in conjunction with 401K plans or IRAs plans. The Roth plan type will alter the taxability of the plan funding. With the other plans discussed the contribution to each plan will be made pre-tax and will grow tax deferred. The Roth plan type taxes the contribution on the front side (at time of contribution) and then plan assets will grow tax deferred and can be withdrawn during retirement tax free.
It should be noted that taking distributions from any plan prior to age 59 ½ could have negative tax consequences and/ or tax penalties. Please discuss the distribution rules with a financial advisor or tax advisor/CPA prior to making a distribution to ensure understanding of the tax impact to your situation.
Small business owners can greatly benefit from the establishment of a retirement plan and they have many options to consider when making a selection. Business owners should work to find the best plan suited to their needs and the needs of their employees.