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Even with the global recession in full swing, some small businesses are still growing and looking for ways to improve and keep the best employees. Offering a retirement plan can provide small businesses with tax benefits while also helping to attract and retain talented workers. What's more, some of them are specially designed to be inexpensive and easy to administer.
401(k) Plans
The most widely used retirement plan offered today, the 401(k), can be offered by businesses of any size. Very small businesses typically avoid them, though, because of the potential administrative burden they can create. Employees can contribute up to a certain amount set by the employer or up to $16,500, whichever is lower, and employer contributions do not count toward this amount. Those 50 years and older can contribute an additional $5,500 per year. Contributions are made by the employee on a pre-tax basis, and earnings on the plan are not taxed until funds are withdrawn. The employer's costs, including plan contributions, are tax deductible. Because earnings can be reinvested for decades without being taxed, they can compound and create a much larger retirement nest egg than if earnings were subject to taxation.
An alternative plan, the Roth 401(k), works slightly differently. Instead of being funded with pretax dollars that are taxed at distribution, Roth 401(k)s are funded with income that is already taxed, but contributions grow tax-free. Distributions are not taxed, as long as they are made after the participant reaches age 59½, dies or becomes disabled. In addition, at least five tax years must pass after the participant's first contribution.
The employer determines how long the employee has to work before becoming eligible for plan benefits (i.e., when the employee is "vested"), and pre-approved plan documents are available that can reduce the administrative burden for small businesses. Employers typically match employee contributions to some extent, but that is not a requirement.
Businesses with up to 100 employees can avoid the administrative burden of nondiscrimination testing (proving that the plan is not favoring key employees, such as owners) by establishing a SIMPLE (Savings Incentive Match Plan for Employees) 401(k) plan.
When employers use a SIMPLE 401(k), highly compensated employees can maximize benefits, regardless of the level of participation by other employees, as long as they meet other requirements. For example, unlike with a traditional 401(k) plan, employers are required to make contributions for all employees who received at least $5,000 in compensation the previous year—and all contributions are 100 percent vested.
As with a traditional 401(k) plan, employee contributions are optional. However, with the SIMPLE plan, the employer is required to make a matching contribution of up to 3 percent of each employee's pay, or a non-elective contribution of 2 percent of each eligible employee's pay. Employees can contribute up to $11,500 for 2009. No other contributions can be made to this plan or to any other retirement plan the company may have.
SIMPLE IRA
The SIMPLE IRA is designed for businesses with up to 100 employees who each earned over $5,000 the preceding year and do not have another plan in place.
Employees are eligible if they earn more than $5,000 in either of the two preceding years and earn at least that much in the current year. The contribution limit for each employee, including business owners, is $11,500 for 2009, plus a $2,500 catch-up for employees over age 50, so neither employees nor employers can contribute as much for themselves as they can with some other plans. Withdrawal before age 59½ carries a penalty of 25 percent during the first two years of participation, after which the penalty drops to 10 percent.
One advantage of the SIMPLE IRA is that it creates little administrative burden, discrimination testing is not required and plan documents do not need to be filed with the IRS. The deadline to establish a SIMPLE IRA plan is Oct. 1 of the current tax year.
Profit-Sharing Plans
Employers using profit-sharing plans determine a percentage of profits they wish to contribute to a retirement plan. The limit is 20 percent of profits and individually up to 25 percent of salary, up to $49,000, for the 2009 plan year. Employees cannot contribute to profit-sharing plans.
Profit-sharing plans create an incentive for employees to make the business more profitable, since the more money the business makes, the greater the amount that goes into their plan. If the business is not profitable in a given year, of course, no contributions are necessary. Eligibility is based on the company's vesting schedule, and professional assistance is typically needed for account administration.
When deciding which plan fits your needs best, consider your goals and the makeup of your workforce. Choose a plan that will serve your business not only today, but for many years. The right plan can be good for business and your personal retirement. For a primer on this topic, see Publication 560 on the IRS' Web site, www.irs.gov.