Retirement Plans for Small Businesses
Many of the requests we get from business owners around this (tax preparation) time of year relate to lowering the tax bill or saving for retirement. Many contribute to retirement plans steadily throughout the year, but several business owners also make last minute contributions to their plans as they figure out their tax liability and hit that ‘maximize contribution’ button in Turbo Tax. By choosing the right plan type for your business, you may be able to do a better job saving for retirement and possibly improve your cost structure as well.
Generally speaking, small business owners have three types of plans available to them: SEP, SIMPLE and Qualified Plans. SEP and SIMPLE plans are based on, and act very much like, Individual Retirement Accounts (IRAs). A Qualified Plan is much more complex and can be more costly, but may also allow a business owner to save more for retirement than the other plan types and can allow much greater flexibility in terms of plan terms and contributions.
Simplified Employee Pensions (SEP) Plans. Despite the use of the word Pension in the title, these plans really function more like IRAs. When an employer adopts a SEP, they set up an IRA (a SEP-IRA) and agree to make a contribution to each employee’s SEP-IRA (including the owner’s) based on a percentage of their compensation. Employers can place some restrictions on who can participate, but they are relatively minimal as these plans are designed for maximum participation and easy administration. Contribution limits are also fairly high, up to $52,000 in 2014 but are made entirely from employer contributions; employees cannot contribute directly by salary reductions.
The biggest downside for employers is that there is generally very little flexibility in allocating contributions to the accounts. Thus an owner putting 10 percent into the plan for him or herself would also typically have to contribute 10 percent or each employee. On the positive side, these plans may be set up and funded after year-end (but must be funded before the tax return is filed).
Savings Incentive Match Plan for Employees (SIMPLE) Plans. Unlike a SEP-IRA, a SIMPLE IRA plan is a salary reduction plan, although employer contributions are also required. Salary deferral contribution limits are generally capped at $12,000 and employers are required to make matching contributions of between one-to-three percent of salary. Thus the total amount that can be put away by a business owner under a SIMPLE plan is often less than with a SEP plan, but there is more flexibility to work with multiple employees. The biggest downside for employers is the mandatory employee contributions and the employee participant limit; SIMPLE IRAs cannot be used by companies with more than 100 employees.
Qualified Retirement Plans. The plans we normally think of as retirement plans – 401ks and pensions – fall into this general category. A Defined Contribution plan, including 401k plans, is a plan in which the employer promises to put a certain amount into an account for the employee up front, but employees are not promised a specific result. A Defined Benefit (pension) plan is one in which the employer promises to pay the employee a certain amount later on, and is responsible for contributing to the plan and investing to fund the promised benefit. 401k plans have become popular with employers because they are generally cheaper to administer and the employer is relieved of the risk of poor investment results.
Qualified plans are more complex to administer, and most businesses will need to hire a Pension Administrator to assist them in the design and management of the plans. The advantage is significantly more flexibility in allocating retirement plan contributions. With defined benefit plans, employers can also generally make much larger contributions to their plans because of the need to fund large benefit payments over many years. There are minimum funding requirements which can be onerous for some employers.
Employers have lots of plan types to choose from, and a Certified Financial PlannerTM professional can help you choose the plan that meets your needs and your specific circumstances.
This column is prepared by Rick Brooks, CFA, CFP®. Rick is Vice President for Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Rick can be reached at (858) 755-5166, or by email at brooks@bfadvisors.com. Rick and his family live in Mission Hills.
Category: Business, Local News
