Which Retirement Plan is Right for My Business?

solo-401kAccording to the U.S. Small Business Administration, almost 72% of workers in small companies have no retirement plan available through the company. An additional 9% have a plan but choose to not participate. That leaves only 1 in 5 workers participating in a retirement plan. Most of these workers cite eligibility requirements and an inability to afford contributions as reasons why. Smaller business state that the main reasons why they do not offer a retirement plan are costs of running the plan, and the time required to maintain it.

Even with all those sad statistics, there are some great reasons to implement a retirement plan if you are a business owner. A retirement plan is a great way for a small business owner and his employees to save for the future. In addition, if you own your own business these plans offer greater contribution limits, allowing you to save more and defer taxes. A good retirement plan is considered the number two benefit behind health insurance. So they can actually help you attract and retain employees too.

Tax Benefits
A retirement plan can have significant tax advantages:

  • Contributions are deductible when made
  • Contributions are not taxed to the employee until withdrawn from the plan
  • Money in the plan grows tax deferred

Types of Plans
There are two basic types of business retirement plans. The first are IRA-based plans, such as SEPs and SIMPLEs, and qualified plans like 401(k)s and profit sharing plans. The latter being more complicated and requiring more expense to maintain. With qualified plans assets must be held by a trust or insurance company. As opposed to IRA-based plans are owned by the employee and the contributions are vested immediately. Qualified plans usually have a vesting schedule that require employees to work a certain number of years before the money is completely theirs.

Profit-Sharing Plans
Profit-sharing plans only allow you the employer to contribute on behalf of the employees. Contributions on your behalf are discretionary. Therefore, if you have a profit, kick in some cash and get a tax deduction. If you had a difficult year, then you can reduce the contribution or skip it altogether. Keep in mind however, you must contribute periodically for the plan to remain qualified. Each participant has a separate account under the profit-sharing plan and contributions cannot exceed $50,000 or 100% of the employee’s compensation in 2012.

401(k) Plans
The 401(k) plan is probably the most popular plan with employees and business owners. According to the Department of Labor, 401(k) plans currently hold about 3 trillion dollars. With a 401(k), employees can defer pre-tax dollars and/or Roth contributions in 2012 up to $17,000 of their pay ($22,500 if they are over 50). Participation is generally allowed after being employed for a year.

As an employer you can also make contributions on behalf of your employees called a match. Combined employee and employer match cannot exceed $50,000 or 100% of compensation. Matching contributions are usually vested immediately. 401(k) plans require complicated testing each year to ensure that benefits are not skewed toward higher paid employees. Discrimination testing does not have to be performed if you adopt a Safe Harbor 401(k) plan. A common safe harbor election is to match 100% of employee deferrals up to 3% of compensation.

A SEP allows you to set up an IRA for yourself and each employee. You contribute the same percentage to each participant. You do not have to make a contribution every year, so you do have a little flexibility in a lean year. In 2012 your contributions for each employee is limited to the lesser of 25% or $50,000. Self-employed sole proprietors use this plan quite often for it’s high limits and simplicity.

SIMPLEs are available to your business if you have less than 100 employees. Your employees can defer pretax $11,500 ($14,000 if over 50) in 2012. You must match your employees contributions dollar for dollar on the first 3% of pay, or make a 2% fixed contribution for each eligible employee. The 3% match can be reduced to 1% in any two of five years. SIMPLE plans are very low cost and simple to set up.

Which plan is right for your business?
There are so many plans available that were not even mentioned here. Each plan has unique advantages and disadvantages, so you’ll need to clearly define what you want to accomplish. For example:

  • Do you want to maximize your own retirement savings?
  • Do you want your employees to be able to contribute?
  • Do you want flexibility to skip employer contributions or match?
  • Do you want lower costs? Simple administration?

Once you answer these questions, it will guide you to the plan that will be the best fit for your business. For more information or a personal consultation, write me at david@lexwealth.com, or call me at (859) 225-2596.