Retirement planning is an essential part of any business, no matter how big or small. After all, a large reason that people work so hard for such a large portion of their lives is to save up for the many goals they have in retirement. Businesses with fewer employees face a different set of challenges from larger firms in context to the types of plans that may be advantageous to consider. This guide goes over the many options that small businesses have available to them, who the account options are good for, and the different benefits and downfalls each account may have.
Individual Retirement Accounts (IRAs) are a popular option for small businesses looking to offer retirement plan options to their employees. These accounts can be differentiated into three separate kinds of accounts that mainly differ on basis of the size of contributions to accounts, when the money in the account is taxed, and how much can be contributed to the account on an annual basis.
One of the main distinguishing factors of Traditional IRAs is that the account is set up by the individual, not the employer. As such, only the individual who opens the account can make contributions to the account, which could limit the account growth significantly over time when we consider the power of compounding account growth with multiple contribution parties. That being said, individuals with Traditional accounts are afforded more freedom as it relates to the selection of investments within their account when compared to employer-sponsored retirement plans. Traditional IRAs are given a maximum annual contribution of $6,000, although individuals over the age of 50 are able to contribute $7,000 on an annual basis.
Roth IRAs are similar to traditional IRAs, considering they are accounts set up by the individual, not the business. They also have the same annual contribution limits for those under and over the age of 50. The main difference between the two accounts is when the money in the account is taxed. Traditional IRAs are taxed when the money is taken out in retirement, while Roth IRA accounts are taxed when the money enters the account. As such, the money in the account is free to grow tax-free and leads to less ambiguity in relation to how much will actually be in the account when the point of retirement is reached.
Different from Traditional IRAs, Simple IRAs are retirement accounts that are set up through employers. That being said, Simple IRAs allow not only the employee to make contributions to the account, but the employer as well. This is a low cost, easy to administer plan that has two options for the amounting employer contributions. First, the employer can choose non-elective contributions to employee accounts at 2% of eligible employees’ compensation rate. The other option is for the employer to match the dollar to dollar contributions of the employee to the account, up to 3% of their compensation amount.
Simple IRAs also differ from standard IRAs on basis of the amount of yearly contributions to the account. Higher contribution limits allow for individuals under the age of 50 to contribute up to $13,500 on an annual basis. Individuals over the age of 50 are allowed a maximum contribution amount of $16,500. As an employer-sponsored retirement plan option, there will likely be fewer investment options for Simple IRAs as opposed to Standard IRAs. Another important detail to note is that participation in a Simple IRA doesn’t prevent employees from opening independent standard or Roth IRA accounts.
SEP IRAs are a great retirement account option for self-employed individual and business owners wanting to make contributions to employee retirement accounts at low administrative costs. SEP IRAs have significantly larger employer contribution rates than previously discussed IRA accounts, with the general ability to contribute up to 25% of the employees’ annual compensation to the account. On the flip side, employees are unable to make contributions to their own accounts as they would have been able to with other employer-sponsored retirement accounts such as Simple IRAs.
A big advantage of SEP IRAs is the fact that you can set up and fund these accounts for the prior tax year. So in years where you might have received a particularly high tax bill, since contribution to your employees’ accounts are tax-deductible, you could make large SEP account contributions to lessen the impact of the tax burden. You are able to make contributions to accounts until you file your taxes, so you can potentially wait until the month of October to make contributions to SEP IRA accounts. A benefit to SEP IRAs as opposed to options such as 401(k)s, is that there is no filing process involved.
401(k) For Small Businesses
Generally, 401(k)s for small businesses are for companies with 1,000 employees or less. These 401(k)s allow contributions from the employer and employee alike. Contributions to employee accounts are tax-deductible for the business and can account for anything up to 25% of the employee’s annual salary. 401(k)s for small businesses must file an IRS from 5500, which details more about your business, how many retirement plans your business has, which plans you selected, and more. Individuals with 401(k)s also have full capability to make contributions in an IRA account in the amount of the lesser of up to 100% of compensation or up to $19,500 a year for those under the age of 50, and $26,000 for those over the age of 50.
Employers may also choose to put certain stipulations in place regarding eligibility for plan benefits. This generally includes some form of vesting period, which dictates the age and number of years worked that must be fulfilled before employees are eligible to open a 401(k). There is also the option to add certain stipulations to grant employees full capabilities to make contributions to an account (that the employer may match), however, the employee must work a detailed number of years in order to retain the full amount of employer contributions in the account, as well as the potential to lose any growth on the account other than the self-made contributions alone.
On a side-note, not all small businesses have a great number of employees. In fact, some small businesses might not have any employees except you and potentially a spouse. Solo 401(k)s are for one-person business owners who want to make the highest contribution amount to their retirement account as possible. These accounts allow for yearly contributions of the lesser of 100% of your compensation, or $19,500 for individuals under the age of 50, and $26,000 if you are over the age of 50. On top of this, the business is able to make contributions to the account in the amount of up to 25% of annual compensation. If you have a Solo 401(k)s, you are also allowed the capability to make contributions to IRA accounts.
While more expensive to enroll in than the plan offerings we discussed previously, defined-benefit plans are often seen as a way to ensure a comfortable retirement to employees lucky enough to be offered these plans, which comes out to be only about 10% of private employees in the American job market. Defined-benefit plans offer a fixed-benefit in retirement in the form of payment per year when you are no longer working, which is associated with tenure in the workplace and salary of the employee at the time of retirement.
The employer funds and manages the investments that will in turn be distributed on a yearly basis to retired employees. Unlike other retirement plan options such as 401(k)s, the employee is guaranteed the funds in retirement, no matter the performance level of the investments in the fund. The employer becomes responsible for covering the cost until the individual reaches the end of their life, in which case the plan is sometimes transferred over to a spouse or heir.
Based upon the cost associated with creating and managing them, defined-benefit plans are usually reserved for high-income professionals including lawyers, dentists, family businesses, or other small entities. As contributions to the pooled funds are tax-deductible, the high contribution rates allow a great way to shelter a large amount of the business’ money from taxes. A large reason behind the large cost associated with these plans is that you will need to hire an actuarial professional to determine the funding levels to the account in order to create the defined-benefit for employees that will be sustainable in the future. Additionally, you’ll need to file form 5500 with the IRS in order to maintain this type of retirement plan.
Selecting the Plan That’s Right For Your Small Business
Every business has different dynamics, taking into account factors such as how old the business is, how stable your profit margins are, and how much the owners, business, and employees are all respectively earning in income. Considering that plans all have varying levels of contribution maximums, you’ll want to choose the plan that closely matches the size of your business, so that you can also maximize your businesses tax benefits. Employee benefits are also an increasingly important aspect of the job determination process for new employees. Even more so than an increase in pay, good benefits can be a large drawing factor to new, quality talent when you are looking to expand your team.
After deciding on the type of retirement plan that is right for you and your small business, you’ll want to look for a provider that can offer the exact plan and services that your business needs and is willing to pay for. While small businesses have less administrative and management duties in proportion to their smaller number of employees, there is also the increased likelihood that it will be harder for you to divert an employee from their everyday tasks to managing the many moving parts of successfully offering retirement benefits to employees.
In order to alleviate the burden this could have on small businesses, there is the option of hiring on third-party plan administrators or financial advisors who can help you to make decisions that will save your business and employees a larger amount of money, and allow you the freedom to be more effective and efficient with your use of time while at work. A downside to this, is the fees associated with hiring a third party to manage these moving parts, let alone hiring a full-time employee to manage HR-related tasks such as company retirement benefits.
Even after you put a plan in place for your company’s retirement plans, it will require diligence and upkeep to make sure the plan you offer stays relevant, accurate, and competitive. As a small company, over time, it’s not uncommon to see an addition of employees. It’s also not uncommon to expect that the financial size of your company will grow over time, and making contributions to employees’ retirement can provide significant tax shelter as you move up tax brackets.
Retirement Planning is Essential for Small Business
Retirement planning is an essential part of any business, small businesses perhaps even more so. Employers should consider and ensure that the benefits they offer employees in preparation for retirement are quality enough that you’ll be able to remain competitive and attractive compared to competitors in order to keep attracting new, quality talent. Once you offer retirement benefits, it’s important that the process is executed and maintained professionally and with accuracy to avoid making costly mistakes: retirement planning isn’t something that should have any ambiguity. Through your reading and decision making, while the amount of time devoted to making a selection that is best for your small business may seem cumbersome, both you and your employees will be happy that you did, reaping the benefits of putting a well thought out plan in place that allows all employees to realize the kind of retirement that they envision for themselves down the road.
If you need help weighing your business options, then it’s time to work with professionals. Here at Client Focused Advisors we specialize in working with small business owners. Contact us today to weigh your options.