Small Business Plans
Small businesses are often at a disadvantage when trying to lure and hire key talent. Often, they can't compete with splashy benefits and perks that come with corner offices. But many small business owners immediately diminish their chances by failing to offer even the most basic of employee benefits—a retirement plan. There are many options available:
- Simplified Employee Pension (SEP). Companies of any size can establish a SEP, but their low administration costs and minimal amounts of paperwork are particularly attractive to small business owners. Under a SEP, an employer makes annual contributions on an employee's behalf, which can range from zero to a maximum of 15 percent of an employee's salary each year, or $25,500, whichever is less. Contributions are tax-deductible and grow on a tax-deferred basis. Some disadvantages of SEPs to employers are that they require immediate vesting, and part-time employees must be offered participation. Another disadvantage of the SEP is that employees can't contribute to a SEP, making the employer completely responsible for the employee's retirement savings.
- Money-purchase plans. Here, employers make fixed contributions every year that are calculated as a percentage of the employee's salary, up to 25 percent, or $30,000, whichever is less. The advantage of the money-purchase plan is the high-contribution limit of 25 percent. The disadvantage of this higher-contribution limit is that once the percentage is set, the employer is required to contribute the same percentage every year, regardless of company profits.
- Profit-sharing plans. Profit-sharing plans make the most sense for self-employed workers and unincorporated businesses. Similar to SEPs, they allow the employer to make contributions of up to 15 percent of employees' pay on their behalf, with a maximum contribution of $25,500. The advantage of the plan is that the employer can change or modify the contribution level each year without penalty. The disadvantage to employees is that the maximum contribution percentage is 15 percent.
- Age-weighted plans. Age-weighted plans assume that older employees should receive larger annual contributions because they are closer to retirement and have shorter funding periods. Age-weighted plans are suitable for any size business and serve an advantage when the business owner and highly compensated employees are significantly older than other employees are. The disadvantage with age-weighted plans is the increased cost of administration due to their complexity.
- Savings Incentive Match Plan for Employees (SIMPLE). Any type of business with up to 100 employees, including tax-exempt corporations, can use a SIMPLE. An employee can defer a portion of their salary tax-free until they retire, limited to $6,000 or 100 percent of their compensation per year, whichever is less. SIMPLEs do require immediate vesting and part-time employees are eligible if they have been paid at least $5,000 in at least two of the preceding five years. The employer can match, dollar for dollar, the first 3 percent of salary that a participating employee defers into the plan in at least three of any five consecutive years and then match 1 percent of that salary in the remaining years or make an across-the-board contribution of 2 percent of salary to all eligible employees.
- Safe Harbor 401(k). A new alternative, the Safe Harbor 401(k) is exempt from discrimination testing and is available for use by companies with less than 100 employees. The employer must either make a contribution of 3 percent of pay for all eligible employees, or they must provide a 3 percent dollar-for-dollar match, plus 50 cents on the dollar for the next 2 percent for any employee that participates in the plan.
- Nonqualified plans. Companies of any size can avoid contribution restrictions by establishing nonqualified retirement plans, but they sacrifice tax benefits. When a plan is not qualified, employees cannot make use of their assets until they are taxed upon them. Usually, such plans are designed for a select group of employees integral to the company, such as owners and key employees.
- Other options. Employers can combine plans, such as an SEP and a money-purchase plan, which, under the right circumstances, can increase contributions from 15 percent to 25 percent a year. Another common occurrence is the combination of a money-purchase plan with a profit-sharing plan. This gives employers flexibility in annual contributions, where they set aside a fixed percentage each year through the money-purchase plan and supplement those contributions using the flexibility of a profit-sharing plan.
With all the options available, it shouldn't be too hard to find a plan that fits your company's specific needs. Yet, the rules continue to evolve, so it is critically important that you obtain the appropriate guidance before committing to any plan.