A good retirement plan can help a small business successfully compete with large companies when recruiting employees, improve employee retention and reduce the company’s taxable income.
It also can help business owners save for their own retirements.
Many options are available to small businesses interested in providing retirement plans to their employees. The major differences between retirement plans are how contributions are made to the plan and how much administration is required.
Three of the most common types of retirement plans offered by small businesses are:
The simplified employee pension (SEP IRA)
A SEP can be implemented by any type of business entity, but is best suited for small companies with fluctuating profits that do not want to deal with annual reporting or administration. In a SEP plan, the employer makes discretionary contributions in any amount up to 25% of the employee’s eligible pay or $41,000 (whichever is less). The amount of the contribution can vary or be discontinued at any time. Employees cannot contribute to a SEP IRA and are immediately 100-percent vested in the employer’s contributions.
Businesses can receive the tax benefit of contributions to a SEP plan for the prior year if the plan is established before the due date of the company’s tax return (including extensions). The main disadvantage to the SEP plan is that all employees who earn over $450 (indexed for the cost of living) in the plan year and have worked for any part of three of the last five years must be included in the plan, even if they no longer work for the company when the contribution is made. Therefore, a SEP plan may not be the best choice for a company that employs seasonal staff.
The simple IRA
A simple IRA can be offered by nearly any business entity with 100 employees or less who earn $5,000 or more annually. The company cannot offer any other type of retirement plan and must be willing to make annual contributions to its employees. Employees can contribute up to $9,000 (not to exceed 100 percent of compensation) to the plan and are immediately 100-percent vested in the employer contributions. Employers are required to make either a matched contribution to participating employees or a non-elective contribution to all eligible employees. Simple IRA plans are best suited for employers who want to encourage employee retirement savings while avoiding costly administration. Simple IRAs require a 60-day notification period before the plan becomes effective. Plans must be set up by Oct. 1 so contributions can be made for the current calendar year.
The 401(k)
Perhaps the best known type of retirement plan, the 401(k) is more complicated and expensive to administer than either the SEP or simple IRA. A 401(k) plan is a profit-sharing plan with an added feature that allows employees to make contributions to the plan.
It is best suited for employers who want to encourage employee savings. Employers can choose to restrict employee eligibility within certain limits, or make the plan available to all employees. Employees can contribute up to $13,000 per year to the plan. Employer contributions are generally discretionary, and vesting schedules of up to six years are available.
These plans can be designed many different ways and can include safe harbor, age weighted or cross-tested provisions.
The major disadvantage to a 401(k) plan is the cost of administering the plan, but the safe harbor provision can reduce these expenses, or the employer can require the plan to pay all administrative expenses.
There are many considerations for a small business interested in offering a retirement plan. Company size, revenue and the ability of the employer to meet reporting requirements are only some of the factors that must be considered.
What may at first seem like the perfect plan for a business may not actually be the best choice when the number of employees participating and the amount of owner vs. employee contributions are calculated.
With the right structure, most small businesses can realize the benefits of offering a retirement plan.
Liz Kaiser, CPA,
is a shareholder with
the accounting firm of Winter, Kloman, Moter & Repp S.C., which has offices in Elm Grove and Oconomowoc. She can be reached at
(262) 797-9050 or LizK@wkmr.com.
September 3, 2004, Small Business Times, Milwaukee, WI
