Whenever advertising or articles regarding pension plans are mentioned, they are usually ignored by small business owners and the self-employed. Small businesses are often under the impression that pension plans are only for large corporations and do not apply to them. However, by ignoring these messages they are missing the opportunity to take advantage of the benefits that pension plans have to offer.
Businesses that offer this type of fringe benefit increase job satisfaction among their employees which can often result in a decrease in staff turnover. Another benefit pension plans can provide significant tax deductions for business owners and deferred earnings for employees.
Nowadays there are an abundance of plans and options to choose from. Many plans are very convenient to implement and require very little paperwork. So, there is no time like the present to implement a retirement plan for you and your employees.
In order to choose the plan that fits your company’s needs, you must begin with a sound understanding of what your options are. There are pros and cons to every plan so each should be carefully considered. To assist you in making the right decision for your company, below is an overview of the current and most common plans:
The 401(k) Plan
A 401(k) plan is a retirement plan sponsored by employers. With this type of plan, employees may choose to have a portion of their salary deferred to any of the 401(k) investment choices that have been selected by the employer. The employer may also contribute to the employee’s 401(k) by matching a portion of the investment. The benefit of a 401(k) is that employees are not taxed on the contributions they or their employers make until they withdraw from the plan. Another benefit is that accumulated earnings on the account are tax-deferred as well.
A 401 (k) can be more complicated to establish and maintain then other types of plans and there are annual IRS reporting requirements associated with it as well. Also, the law requires that if low compensated employees do not contribute enough by the end of the plan year, then the limit is changed for highly compensated employees.
There are individual 401 (k) plans that can be set up by a company (incorporated or unincorporated), in which the owner is the sole proprietor and/or only employee. The key advantage to plans such as these is that they permit larger contributions than other plans. The individual 401(k) also tends to be a little less complicated than the traditional 401(k).
Simplified Employee Pension (SEP) Plan
Often referred to as a SEP-IRA, this is essentially a retirement plan set up by a small business employer or by a self-employed person. This pension plan allows employers to contribute to SEP-IRA plans on behalf of their employees in an amount greater than traditional IRA limitations. The main advantages of the SEP-IRA to the employer is that the administrative burdens are few, the plan is simple to install, and it does not have the start-up and operating costs of conventional retirement plans.
Because you decide the amount to be contributed each year to SEPs, this plan can offer a great deal of flexibility. However, they can only be funded through employer contributions and annual contributions are limited to 25 percent of each employee’s pay. Another benefit of SEPs in contrast to other plans is that you can establish it up to the extended due date of your tax return.
Savings Incentive Match Plan for Employees (SIMPLE)
The SIMPLE plan gives small businesses an affordable way to offer retirement benefits through employee salary reductions and matching contributions similar to the SEP. A SIMPLE plan is available to yourself and eligible employees and is made up of individual retirement accounts (IRAs). A SIMPLE plan can also be set up as a 401(k) plan. Both of these types of SIMPLE plans can be established easily using a “model” plan document which is available from the IRS. With a SIMPLE plan, employers offer matching contributions equal to employee contributions or fixed contributions equal to a percent of employee wages.
Requirements and limitations for the SIMPLE plan dictate that employers must have fewer than 100 employees and must generally be established before October 1st of the calendar year. Employers that currently sponsor another retirement plan generally cannot sponsor a SIMPLE plan.
The Keogh (H.R. 10) Plan
A Keogh (or HR 10) plan is a tax-deferred retirement savings plan for self-employed individuals and their employees. Most self employed individuals who have earned income from self-employment are eligible under this plan.
Keogh plans have gained popularity in recent years thanks to tax legislation that has made it possible for contributions made to Keogh plans equal to that of plans held by large corporation. Outlined below are the two key types of Keoghs:
1. Defined contribution plans: These plans come in a few different forms such as target benefit plans, money purchase plans, and profit sharing plans. Each plan requires contributions that are based on either a percentage of an employee’s wages or percent of an owner’s profits. The amount the contributions have accumulated by retirement will dictate what benefits the participants will receive when they retire.
2. Defined benefit plans: Plans such as these have a set amount of retirement benefit that the plan will pay out upon retirement and contributions made are based upon the payout amount. Any benefit that a participant will receives upon retiring is limited by law and requires actuarial calculations to determine the amount of annual contribution needed.
One major drawback to all Keogh plans is that the reporting requirements are more complicated than the SEP and SIMPLE-IRA plans. Another disadvantage is that a business owner is required to make contributions for eligible employees and therefore cannot only cover themselves.
Contributions can be made to Keogh plans up to the company’s tax return due date (extensions included). However, they must be established no later than December 31st of the tax year that you will begin taking a deduction for contributions.