Retirement Plans for Small Businesses

small business retirement plansIf you’re self-employed or own a small business, a retirement plan can help you and your employees save for the future and at the same time have significant tax advantages such as:

- Your contributions are deductible when made
- Your contributions aren’t taxed to an employee until distributed from the plan
- Money in the retirement program grows tax deferred, or in the case of Roth accounts, potentially tax free

Types of Plans

There are 5 common types of retirement plans for you to choose from:

  • SEP IRA
  • SIMPLE IRA
  • 401(k) Plan
  • Profit-Sharing Plan
  • Defined Benefit Plan

Retirement plans are usually either IRA-based (like SEPs and SIMPLE IRAs) or “qualified” (like 401(k)s, profit-sharing plans, and defined benefit plans). Qualified plans are generally more complicated and expensive to maintain than IRA-based plans because they have to comply with specific Internal Revenue Code and ERISA (the Employee Retirement Income Security Act of 1974) requirements in order to qualify for their tax benefits.

Which Plan is Right For You?

With a dizzying array of retirement plans to choose from, each with unique advantages and disadvantages, you’ll need to clearly define your goals before attempting to choose a plan. For example, do you want:

  • A plan with lowest costs? Easiest administration?
  • To maximize the amount you can save for your own retirement?
  • A plan funded by employer contributions? By employee contributions? Both?
  • A plan that allows you and your employees to make pretax and/or Roth contributions?
  • The flexibility to skip employer contributions in some years?

The answers to these questions can help guide you and your retirement professional to the plan or plans most appropriate for you.

SEP IRA

A SEP IRA allows you to set up an IRA for yourself and each of your eligible employees. You contribute a uniform percentage of pay for each employee, although you don’t have to make contributions every year, offering you some flexibility when business conditions vary. For 2013, your contributions for each employee are limited to the lesser of 25% of pay or $51,000. Most employers, including those who are self-employed, can establish a SEP.

SEPs have low start-up and operating costs and can be established fairly easily.

SIMPLE IRA

The SIMPLE IRA plan is available if you have 100 or fewer employees. Employees can elect to make pretax contributions in 2013 of up to $12,000 ($14,500 if age 50 or older). You must either match your employees’ contributions dollar for dollar–up to 3% of each employee’s compensation–or make a fixed contribution of 2% of compensation for each eligible employee.

SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs are set up for each employee.

Profit-Sharing Plan

Typically, only you, not your employees, contribute to a qualified profit-sharing plan. Your contributions are discretionary–there’s usually no set amount you need to contribute each year, and you have the flexibility to contribute nothing at all in a given year if you so choose.

The plan must contain a formula for determining how your contributions are allocated among plan participants. Contributions for any employee in 2013 can’t exceed the lesser of $51,000 or 100% of the employee’s compensation.

401(k) Plan

The 401(k) plan has become a hugely popular retirement savings vehicle for small businesses. With a 401(k) plan, employees can make pretax and/or Roth contributions in 2013 of up to $17,500 of pay ($23,000 if age 50 or older). These deferrals go into a separate account for each employee and aren’t taxed until distributed.

You can also make employer contributions to your 401(k) plan–either matching contributions or discretionary profit-sharing contributions. Combined employer and employee contributions for any employee in 2013 can’t exceed the lesser of $51,000 (plus catch-up contributions of up to $5,500 if your employee is age 50 or older) or 100% of the employee’s compensation.

401(k) plans are required to perform somewhat complicated testing each year to make sure benefits aren’t disproportionately weighted toward higher paid employees. However, you don’t have to perform discrimination testing if you adopt a “safe harbor” 401(k) plan. With a safe harbor 401(k) plan, you generally have to either match your employees’ contributions (100% of employee deferrals up to 3% of compensation, and 50% of deferrals between 3 and 5% of compensation), or make a fixed contribution of 3% of compensation for all eligible employees, regardless of whether they contribute to the plan. Your contributions must be fully vested.

Defined Benefit Plan

A defined benefit plan is a qualified retirement plan that guarantees your employees a specified level of benefits at retirement (for example, an annual benefit equal to 30% of final average pay). As the name suggests, it’s the retirement benefit that’s defined, not the level of contributions to the plan. In 2013, a defined benefit plan can provide an annual benefit of up to $205,000 (or 100% of pay if less). The services of an actuary are generally needed to determine the annual contributions that you must make to the plan to fund the promised benefit.

As you can see there are a variety of retirement plan options for you to choose from. It is recommended that you speak with your accountant to help you in choosing the correct plan that will fit your needs.

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES

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