A common concern of business owners and employees is whether they will have enough saved for a comfortable retirement. One of the best ways to improve the rate of savings is through an employer sponsored retirement plan. While common among larger companies, small business owners often reinvest a majority of their earnings back into the business as opposed to setting up a plan. As businesses grow, so does the list of benefits a retirement plan can offer business owners and employees.
Qualified retirement plans are vehicles for tax deferred retirement savings. Some allow employees to defer current income into the plan through a payroll deduction. Many offer employers the option of matching employee contributions or adding profit sharing contributions. Retirement plans not only provide a current year tax benefit to participants, they can serve as recruiting and staff retention tools. Many prospective and current employees are aware of the importance of retirement savings, and chances are, competitors have retirement plans in place. For the individual business owner, they also provide an opportunity to diversify their retirement portfolio by building an asset separate from the business.
Deciding which type of retirement plan is appropriate for your business can be difficult without proper guidance. Considerations include number of employees, consistency of cash flow, employee turnover and the intentions of the business owner. Below, I will highlight a few options that may be appropriate for businesses with more than one employee. In a future blog post, I will detail some of the options available to self-employed individuals.
Simplified Employee Pension (SEP) IRA plans are popular for smaller businesses as they have minimal start up and operating costs and allow for contributions up to 25% of each employee’s pay (up to a maximum contribution of $53,000 in 2015). While SEP IRAs are simple to establish, they are limited to only employer contributions. Contributions are a deductible expense to the business and employers have the flexibility of choosing whether or not to contribute each year. When contributions are made, they must be spread equally across all eligible employees using one of 3 formulas: Pro Rata, Equal Dollar, or Social Security Integrated.
This is probably the most widely known employer sponsored retirement plan. This plan allows employees to defer up to $18,000 annually into the plan in 2015 (up to $24,000 if they’re over age 50). In addition to the employee contribution, employers have several contribution options including fixed, matching, profit sharing or no contribution at all. Providing a matching benefit is a great way to incentivize your employees to save and plan for the future. As ERISA covered plans, it is important to make sure eligibility, fiduciary and reporting requirements are met on an ongoing basis. While these plans provide a lot of flexibility, the setup and administration costs may deter very small employers.
High administration costs and long term actuarial risks have driven many companies away from traditional pension plans, but they may still be appropriate for certain professional service groups.
Pensions come in several forms including cash balance, money purchase plans, defined benefit and hybrid plans. Setting up a traditional pension can be time consuming and cost several thousand dollars, but may allow for significantly higher contributions than other qualified plans. While most retirement plans are limited to a total contribution of $53,000, pension contributions are often made based on actuarial data. Actuaries may determine a plan is vastly underfunded when first set up, allowing contributions well in excess of a typical retirement plan’s limit. These are popular among older high earning consultants, contractors, physicians and attorneys.
In summary, investing the time and money in setting up the right retirement plan for your company can save the business and its employees a significant amount in current year taxes while also encouraging saving for the future. There are over a dozen types of retirement plans used in businesses and non-profits but each organization has unique needs, circumstances and goals that factor in to which plan type is most appropriate. In Part 2, I will give an overview of plans available to individual employee-employers.
Eric Schaefer, CFP® is a Financial Advisor with Evermay Wealth Management, an independent fee-only investment advisory firm in Arlington, VA. Eric can be reached by e-mail at ESchaefer@evermaywealth.com or by phone at (703) 822-5696.