Retirement plans. We all want them, but not all employers make them available.
Maybe you’ve hired the first few employees for your small business, you find them to be talented and wish to entice them — plus new hires — with a benefits package that includes plans to build towards their retirement income to supplement both social security benefits as well as their own savings & investments. You have several options from the popular 401(k) to the out of favor but still very much relevant defined benefit plan.
Some advantages to you as the employer to implement these retirement plans include contributions that are tax-deductible, plan assets which grow tax-free, tax credits and other incentives. Plus, a retirement plan can attract and retain better employees, reducing new employee training costs.
These days, retirement can last for 30 years or more and an individual may need up to 80% of their current annual income to retire comfortably, while the average monthly benefit paid by the Social Security Administration is $1,200.
The most popular employer retirement plan is the 401(k). It can be adopted by any employer other than a state or local government entities. Employees can be automatically enrolled or choose to do so individually. Some plans allow employees to defer their contributions as Roth contributions, made with after-tax funds and have the potential to be distributed (contributions + earnings) tax-free.
Employer contributions are not required but may be made to the plan. The most popular employer contributions are matching, and profit-sharing which may be subject to a vesting schedule.
The limit on employee elective deferrals (for traditional and safe harbor plans) is $19,500 in 2020 ($19,000 in 2019), subject to cost-of-living adjustments. The limit on employee elective deferrals to a SIMPLE 401(k) plan is$13,500 in 2020 ($13,000 in 2019).
If permitted by the 401(k) plan, participants age 50 or over at the end of the calendar year can also make catch-up contributions. You may contribute additional elective salary deferrals of $6,500 in 2020 and $6,000 in 2015 – 2019 to traditional and safe harbor 401(k) plans, or $3,000 in 2015 – 2020 to SIMPLE 401(k) plans.
If you establish a 401(k) plan, you can have other retirement plans, be a business of any size, and will need to annually file a Form 5500.
A business of any size, even self-employed, can establish a SEP. The plan can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. Implemented, only the employer contributes to traditional IRAs set up for the employee (for which each is 100% vested). There’s no filing requirement for the employer, and the plan allows for flexible annual contributions.
A SEP IRA is similar to the profit-sharing plan in that it’s funded entirely by employer contributions and there is no set amount that the law requires you to contribute. The plan must cover all employees who are at least 21 and have worked 3 of the preceding 5 years (with current year contribution of at least $600).
The contributions made to an employee’s SEP-IRA cannot exceed the lesser of 25% of the employee’s compensation, or $57,000 for 2020 ($56,000 for 2019).
The SIMPLE IRA plan is available to any small business — generally with 100 or fewer employees. The plan must cover all employees who’ve earned at least $5,000 in compensation in any two prior years. An employer cannot have any other retirement plans and is required to contribute each year either a matching contribution of 3% of compensation to employees making deferrals or 2% contribution for each eligible employee. The employee is always 100% vested in and their contribution is optional.
The amount an employee contributes from their salary to a SIMPLE IRA cannot exceed $13,500 in 2020 ($13,000 in 2019 and $12,500 in 2015 – 2018).
If permitted, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The catch-up contribution limit for SIMPLE IRA plans is $3,000 in 2015 – 2020.
A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, shares many characteristics with a 401(k) plan and is a retirement plan offered by a public education employer or 501(c)(3) tax exempt organization and should be made available to all employees once implemented.
Just as with a 401(k) plan, a 403(b) plan lets employees defer some of their salary into individual accounts. The deferred salary is generally not subject to federal or state income tax until it’s distributed. However, a 403(b) plan may also offer designated Roth accounts. Salary contributed to a Roth account is pre-taxed, but is generally tax-free (including earnings) when distributed.
The limit on elective deferrals is $19,500 in 2020 ($19,000 in 2019). Employees who are age 50 or over at the end of the calendar year can also make catch-up contributions of $6,500 in 2020 ( $6,000 in 2015 – 2019) beyond the basic limit on elective deferrals.
The limit on annual additions (the combination of all employer contributions and employee elective deferrals to all 403(b) accounts generally is the lesser of $57,000 for 2020 ($56,000 for 2019), or 100% of includible compensation for the employee’s most recent year of service.
The defined benefit plan used to be the dominant type of plan offered by an employer. It defined a specific retirement benefit based on a percentage of the employee’s final compensation and years of service. It would be the amount the employee received at end of service, on a periodic basis. Generally, a defined benefit plan may not make in-service distributions to a participant before age 62.
If you establish a defined benefit plan, you can have other retirement plans, can be a business of any size, need to annually file a Form 5500 with a Schedule B, have an enrolled actuary determine the funding levels and sign the Schedule B, and can’t retroactively decrease benefits.
Profit sharing plans can be adopted by any size or type of employer. They’re funded by employer contributions only and there is no set amount that the law requires you to contribute. An employer can apply a vesting schedule to the contributions on a discretionary basis.
If you establish a profit-sharing plan, you can have other retirement plans, and will need to annually file a Form 5500.
Before implementing any plan, begin by learning about the specific ways that money can be put aside for you and your employees’ retirement.
You should operate your retirement plan so that the assets in the plan continue to grow and the tax-benefits of the plan are preserved — covering eligible employees; making contributions; keeping the plan up-to-date with retirement plan laws; managing the plan assets; providing information to employees participating in the plan; and distributing benefits.
In the end, when your plan no longer suits your business, you will close out the plan and notify the appropriate parties.
If you enjoyed this post, feel free to also read “5 Recommended Books for the Small Business Owner or Solopreneur.” You can also contact me for a complimentary consult.