As the plan sponsor, the company will choose a retirement plan by balancing what is most important to the company and its owners against what the tax law allows. For example, a plan that allows the owner of a company to put away the largest dollar amount may require the company to contribute more to its employees and/or incur higher administrative costs.
Plans also differ in other ways including the ability to customize, due dates, whether contributions are discretionary or required, reporting, tax return filings and cost.
Common to most retirement plans is the ability to reduce taxes currently and/or in the future. Congress has used the tax laws to provide incentives to employers and employees to participate in a company plan to help build future retirement security. Employers also find that such plans can help attract and retain employees.
Tax benefits in a plan can include one or more of the following:
- deductions for amounts contributed to the plan.
- tax deferred or tax-free treatment of account balances and
- tax credits to the employer for implementing the retirement plan.
Two of the easier plans to establish are SEP and SIMPLE IRAs, however, they also have limited plan design options as to contribution levels and vesting. These types of plans do not have a tax return filing requirement and therefore do not have a tax related cost.
A SEP IRA can be a good fit when there is a self-employed owner without eligible employees or there is a big gap in pay between the owner/family group and a few eligible employees. This type of plan can also appeal to those who do not want to pay administration costs and desire perhaps the simplest and most flexible plan.
A SIMPLE plan may be an alternative to a startup 401(k) and can appeal to a company where the employees have a low interest in participation and the employer wants a low-cost plan. It is often used for side businesses with low earnings to defer. It is popular because it is easy to establish and generally without administrative fees.
A company can also choose a traditional qualified plan, as they can provide more design options. These plans allow for the use of a vesting schedule, so employees are provided an incentive to stay with the company. The longer the employees are employed with the company, the more they can earn with regard to employer contributions.
Traditional qualified plans can be separated into two categories: defined contribution and defined benefit. Unlike the plans discussed above, there are significant administration requirements and additional costs, both in installing these plans and in maintaining them.
The first, and most popular, type of a defined contribution plan is the 401(k) Plan. 401(k) Plans can be a good option for companies of any size, where there is interest by the employees in contributing to the plan and a commitment by the plan sponsor to pay safe harbor contributions and annual administration fees.
The second category of a traditional qualified plan is the Defined Benefit Plan. It can provide for the largest tax deduction and contribution limits for business owners. It is available as an owner-only plan like the owner-only 401(k). Its important to understand that there are minimum amounts that must be contributed annually, it is more expensive to administer and requires the involvement of an actuary.
The Defined Benefit Plan can be a good option for a highly paid self-employed person who does not have any other employees. It can also be of benefit for such an individual who has a few employees that are, on average, younger than the owner and there is a consistent and reliable surplus cash flow to fund the plan.
There is much to think about in implementing or changing a retirement plan and we are here to help. We encourage you to reach out to us to help you with the process.