When we think of retirement plans, we often think in the broad terms that ricochet around us daily: 401(k) and IRA. Business owners who decide to set up a retirement plan for themselves and their employees quickly find out it's not as simple as two options. There are a multitude of variations on each one, and almost all of us need some level of assistance in figuring out what's best for our companies, especially when they're small.
If you've determined that offering a retirement plan is in your best interests, and all that's left is to set one up, these are some options you should know when you speak with a small business retirement plan expert.
1.) Simplified Employee Pension Plans, or SEP-IRAs. SEP-IRAs are notable because all contributions come from the employer—employees put nothing into it. Employers must make contributions for everyone, with no exclusions. At a glance, this may seem onerous, but it's designed for businesses where the owner is the only employee, or businesses which are very small and heavily reliant on everyone who works for them.
The main strength of an SEP-IRA is that the maximum annual contribution is quite high, especially for the self-employed. The maximum can't the lesser of a flat cap ($55,000 in 2018) or 25% of the employee's W-2 compensation.
One other benefit as an employer is that it's flexible; you don't have to contribute the same amount every year, which can keep retirement plan costs from hurting you badly in a down year. However, if you're confident you can contribute a consistent amount annually, there are more efficient ways to get money to you as the owner—in some cases more than the 25% maximum of an SEP-IRA.
2.) Savings Incentive Match Plans for Employees, or SIMPLE IRAs. SIMPLE IRAs are another great option for small businesses, and may be a more efficient way for owners to save money for themselves than an SEP if they have employees. These plans scale better with a larger workforce; they offer some flexibility to employers on contributions, although less than with an SEP-IRA, and create a solid retirement plan for employees while giving employers stability in terms of knowing the most they'll have to contribute per employee, per year.
The employer has two participation options: match each employee's contributions dollar-for-dollar, up to 3% of the employee's compensation, or contribute a flat two percent of each eligible employee's compensation per year. Under the second option, they would receive the employer's contribution even if they contribute nothing (although they can if they choose).
The strength here is that both options are easy to understand and calculate, and employers should have a relatively easy time figuring out which one makes sense for their companies.
3.) Defined benefit plans. These are your daddy's retirement plans, so to speak, the ones workers in retirement or entering it soon have relied on, and which have not been treated kindly in recent years. However, they have been making a strong comeback under a new name: Cash Balance plans. Cash Balance plans are great for owners who either have a short time horizon until retirement and the ability to save aggressively (up to $380,000+ a year), or have a specific need to lower their taxable income.
4.) 401(k)s. We hear about 401(k) plans all the time for a reason. They're suitable for more than just large corporations; they also offer the most overall flexibility and tax efficiency for small business owners looking to save.
Let's say you're an owner with W-2 wages of $100,000 in a given year. The SEP-IRA limits you to contributing $25,000 of that income. However, if you have a handle on your personal finances and can spare more than that, a 401(k) plan allows you to contribute up to $43,000, reducing your W-2 income by $18,000 on top of reducing pass-through income by the initial $25,000.
401(k)s also offer more flexibility with which employees you can include. Many small businesses rely on part-time (in some cases, very part-time) employees with no need to receive a retirement plan through the company; a 401(k) lets you set up retirement accounts for yourself and any full-timers you rely on, with no requirement to include the part-time workers as well.
Finally, 401(k)s offer vesting options which ensure only employees that stick with you for a certain period of time earn the full measure of your contribution to their retirement plan. For example, with a six-year vesting 401(k), you contribute the agreed-upon amount while the employee works for you, but if she leaves after three years, she only receives forty percent of your contribution. The rest stays in your plan and can be used to reduce the match to you are paying for other employees.
This is especially useful because turnover hurts small businesses more than larger companies. You have a smaller employee base, so every loss creates more of an impact. If your employees need to stay longer to earn the most from their 401(k)s, you give them incentive to stay, and save yourself money if they don't.
No matter what plan sounds best, remember that others exist and it's important to speak with an experienced small business retirement plan expert to plot the course for your company's future. If you're looking for advice on the right plan for you, contact us. We're located in Columbus, OH, but serve clients across the United States, and we can help with your decision.