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The right plan can help you plan for your own retirement as well as that of your employees. "The first benefit of retirement plans is to the business owners who want to contribute money for their own retirement," says Tracy Davidson, president of Davidson Pension Consulting, Corte Madera, Calif. "The plans also promote employee loyalty and retention, because they give people an opportunity to contribute tax-deferred money out of their payroll accounts."
You'll save on taxes three ways: First, employer contributions are deductible from business income. Second, employee contributions are not taxed until distributed to the recipient. Third, money invested in these programs grows tax-free.
If you don't already have a retirement plan, start laying the groundwork now. Already got one? Take some time to review what you have to make sure you are maximizing the benefits for owners and employees. Here's some help.
Pick a Plan
Which plan is right for your business? The answer is often not easy: You can be faced with a bewildering array of options. Some plans require employer contributions; others don't. Some have annual contribution limits; others don't. And the more attractive the plan in terms of contribution limits, the greater the paperwork required.
Bottom line: Picking the right plan means balancing ease of compliance-related recordkeeping with attractive tax benefits. Much of the decision is a judgment call, and you may find yourself changing plans over time.
Before you identify the kind of plan you want, look at yourself as an employer. Ask questions: Why do you want a plan? Do you expect employees to make contributions? Do you employ any highly compensated individuals? How much do you want to contribute each year? How involved do you want to be in administering a plan?
Keep it Simple
Reduce costly paperwork by considering the simpler plans first. "Always look first at the plans that do not require annual governmental reporting," suggests Barry R. Milberg, managing member of Milberg Consulting, Plymouth Meeting, Pa. "Just consider the more complex plans if you are ready to contribute a substantial amount of money and are willing to pay someone to help you remain compliant with federal regulations."So what plans are the easiest to administer? They are called "IRA-based plans," and they come in three varieties:
1. Payroll deduction IRA (Individual Retirement Arrangement), also called a "traditional IRA." You can't find a plan that's easier to administer. All it requires is that the employer fill out an application with a financial institution that sponsors such a plan, such as a bank or insurance company. The employer contributes no money to the plan and has no annual reporting requirement.
Beyond recordkeeping simplicity, the advantages of payroll deduction IRAs lie in their flexibility. Employees get to decide how much money to deduct from their salary to invest in their plans. The amounts can vary annually, and some years can be skipped.
In exchange for the IRA's simplicity and flexibility, there is a disadvantage: The annual contributions for tax year 2013 are limited to $5,500, plus an additional $1,000 for employees over the age of 50.
These plans can be established by individuals without the assistance of employers. However, few people take the initiative absent encouragement from the workplace powers-that-be. Furthermore, the payroll deduction process introduces a weekly regularity and the investment of funds before they enter the employees' pockets. Both features encourage participation.
2. Simplified Employee Pension plan, also called the "SEP IRA." This one is similar to the payroll deduction IRA described above. In this case, though, the employer makes all the contributions. That makes the plan a more powerful retention tool.
Another advantage is that more money can be invested, which makes the plan more valuable to the recipient. The employer may contribute up to 25 percent of each employee's compensation, with a 2013 cap of $51,000.
Like the payroll deduction IRA, there's no required contribution: The employer can decide how much to contribute, or whether to contribute at all, on a year-to-year basis. And overhead is still minimal: The plans require little paperwork beyond an initial submission of a two-page IRS Form 5305-SEP and the requisite payroll recordkeeping.
Unlike traditional IRAs, however, these plans mandate participation requirements: You must offer them to all employees who are over 21 and employed at your business for three of the last five years. And you must contribute a uniform percentage of pay for each employee.
3. SIMPLE IRA Plan, formally referred to as "Savings Incentive Match Plan for Employees of Small Employers." Here's a plan where both the employer and employee contribute. The employee decides how much to contribute each year, up to $12,000 in 2013 (with an additional $2,500 allowed for those 50 and over). The employer must then either match each employee's contribution (up to three percent of each employee's compensation) or contribute a universal two percent of the compensation of all employees eligible to participate, regardless of whether individual employees actually opt to participate.
Once again, the paperwork is limited: You get the plan started by filing IRS Form 5304-SIMPLE and maintain the requisite payroll records.
To use a SIMPLE IRA Plan, though, you must meet certain requirements. Your business must employ fewer than 100 people and you must maintain no other retirement plan. And you must offer the plan to all employees who have earned income of at least $5,000 in any prior two years, and are reasonably expected to earn at least $5,000 in the current year. (Alternatively, you may opt to offer the plan to all employees.)
In all three of the above plans, the amounts employees receive at retirement depend on two things: the amounts they have invested in the plans over the years and the earnings that have resulted from the investments. Funds are taxable when withdrawn by the retired employees. Early withdrawals are subject to penalties.
Save More Money
Maybe the plans discussed above are just fine for your small business. The fact is, though, that there are solid reasons for establishing plans that allow for higher levels of contributions. That can be beneficial in terms of reducing current taxes and building greater retirement savings. The downside of these plans are twofold: They have tougher requirements in terms of recordkeeping and employee participation.
Of the three basic alternatives to IRA-based plans (401(k) plans, profit-sharing plans, and defined benefit plans), by far the most common retirement plan today is the 401(k), which gets its name from the relevant section number of the IRS Code. These plans are popular because they allow contributions by both employer and employee and they allow a high level of contributions. Also, unlike the SIMPLE IRA plans, these plans can be used by businesses with more than 100 employees. (They can also be used by smaller employers.)
For 2013, employees may contribute up to $17,500 annually (and an additional $5,500 for those 50 or older). The employer may also opt to contribute to each employee's retirement account. For 2013, the maximum allowed combined contributions are the lesser of 100 percent of each employee's compensation or $51,000 ($56,500 if you are age 50 or older.)
There is a comprehensive rule for eligibility for 401(k) plans: You are pretty much required to include everyone who is age 21 or older. And there is a significant new recordkeeping hurdle: You must pass an annual "non-discrimination test" to make sure that benefits to owners and highly compensated individuals do not exceed established limits.
Finally, you must file an annual return with the IRS for your 401(k) plan, adding to your usual tax headache.
Sail into Harbor
Do you find an annual discrimination testing too onerous? Or do you have a few highly compensated individuals who want to be able to contribute more to their retirement than what is allowable under the rules of the regular 401(k) plan?
You're not alone. That's why the IRS has established what's called a "safe harbor 401(k)." These plans are deemed non-discriminatory and do not require an annual test. Safe harbor plans can be great for the small shop with highly compensated owners or managers. The reason is that employees might only want to contribute a small percentage of their salaries, but the owners can put in much more.
Here's the catch: You enjoy your safe harbor by agreeing to a new requirement. You must either match each participating employee's contribution (up to three percent of the employee's compensation) or make an across-the-board contribution equal to three percent of each eligible employee's compensation.
Cover Your Bases
This article has covered only the highlights of each type of retirement plan. You may also want to look into profit sharing plans and defined benefit plans, both of which are more complex to establish and maintain but allow for greater levels of contributions toward retirement.
Bear in mind that employers often maintain more than one type of plan. Whatever route you take, get advice from your accountant and attorney, and consider taking on the assistance of a consultant who specializes in employer sponsored retirement accounts. Pick one who does not have a vested financial interest in a given plan. Your advisor should be able to help you file the annual paperwork (for plans requiring it) and assure you are making the correct contribution amounts. Errors can result in costly tax liabilities. There is also help on the web from the Internal Revenue Service at www.irs.gov/Retirement-Plans.
