Retirement plans bring nest eggs and employee satisfaction

Saving for retirement is a laudable goal that often gets put on the back burner. Wouldn't it be great if you and your employees were able to build those savings while lowering your tax burdens?

You can achieve both goals by establishing an employer-sponsored retirement plan for your workers. It's a terrific perk that helps convey a sense of goodwill toward your top talent.

"For the small business owner, retirement plans are attractive for two reasons," says Barry R. Milberg, managing member of Milberg Consulting, Bluebell, Pa. "First, they are a means to attract and retain employees. Second, they can be good vehicles for sheltering taxable income."

The right plan can help you plan for your own retirement, as well as that of your employees. And you'll save taxes three ways: First, employer contributions are deductible from business income. Second, employee contributions are not taxed until they are distributed to the recipient. Third, money invested in these programs grows tax-free.

If you don't already have a retirement plan, start laying the groundwork now. Already got one? Take some time to review what you have to make sure you are maximizing the benefits for owners and employees. Here's some help.

Pick A Plan

What plan is right for your business? The answer is often not easy, and you can be faced with a bewildering array of options. Some plans require employer contributions; others don't. Some have annual contribution limits; others don't. And the more attractive the plan in terms of contribution limits, the greater the paperwork required.

Picking the right plan means balancing ease of record keeping with attractive tax benefits. Much of the decision is a judgment call and you may find yourself changing plans over time.

"Before you identify the kind of plan you want, look at yourself as an employer," says Janice Wargo, an associate in the employee benefits group at the consulting firm of Plante & Moran, Auburn Hills, Mich. "Why do you want a plan? Do you expect employees to make contributions? Do you employ any highly compensated individuals? How much do you want to contribute each year? How involved do you want to be in administering a plan?"

Keep It Simple

Reduce costly paperwork by considering the simpler plans first. "Always look first at the plans that do not require annual governmental reporting," suggests Milberg. "Just consider the more complex plans if you are ready to contribute a substantial amount of money and are willing to pay someone to help you remain compliant with federal regulations."

So what plans are the easiest to administer? They are called "IRA-based plans," and they come in three varieties:

1. Payroll deduction IRA, also called a "traditional IRA"
You can't find a plan that's easier to administer than this. All it requires is that the employer fill out an application form with a financial institution (such as a bank or insurance company) that sponsors such a plan. The employer contributes no money to the plan and has no annual reporting requirement.

Beyond record-keeping simplicity, the advantages of payroll deduction IRAs lie in their flexibility. Employees get to decide how much money to deduct from their paychecks to invest in their plans. The amounts can vary annually and some years can be skipped.

In exchange for the IRA's simplicity and flexibility, there is a disadvantage. The annual contributions are limited to $5,000, plus an additional $1,000 for employees over the age of 50.

These plans can be established by individuals without the assistance of employers. However, few people take the initiative. Furthermore, the payroll deduction process introduces a weekly regularity and the investment of funds before they enter the employees' pockets. Both features encourage participation.

2. Simplified employee pension plan, also called the "SEP IRA"
This one is very similar to the payroll deduction IRA described above. In this case, though, the employer makes all the contributions. That makes the plan a more powerful retention tool.

Another advantage is that more money can be invested, which makes the plan more valuable to the recipient. The employer may contribute up to 25 percent of each employee's compensation, with a cap of $49,000.

Like the payroll deduction IRA, there's no required contribution. The employer can decide how much to contribute, or whether to contribute at all, on a year-to-year basis. And overhead is still minimal. The plans require little paperwork beyond an initial submission of the two-page IRS Form 5305-SEP and the requisite payroll record keeping.

Unlike traditional IRAs, however, these plans mandate participation requirements: You must offer them to all employees who are over 21 and employed at your business for three of the last five years. And you must contribute a uniform percentage of pay for each employee.

3. SIMPLE IRA Plan, formally referred to as "Savings Incentive Match Plan for Employees of Small Employers"
Here's a plan where both the employer and employee contribute. The employee decides how much to contribute each year, up to $11,500 (with additional $2,500 allowed for those 50 and over). The employer must then either match each employee's contribution (up to 3 percent of each employee's compensation) or contribute a universal 2 percent of the compensation of all employees eligible to participate, regardless of whether individual employees actually opt to participate.

Once again, the paperwork is pretty limited. You get the plan started by filing IRS Form 5304-SIMPLE and maintain the requisite payroll records.

To use a SIMPLE IRA Plan, though, you must meet certain requirements. Your business must employ fewer than 100 people and you must maintain no other retirement plan. And you must offer the plan to all employees who have earned income of at least $5,000 in any prior two years and are reasonably expected to earn at least $5,000 in the current year. (Alternatively, you may opt to offer the plan to all employees.)

In all three of the above plans, the amount employees receive at retirement depends on two things: the amount they have invested in the plans over the years and the earnings that have resulted from the investments. Funds are taxable when withdrawn by the retired employees. Early withdrawals are subject to penalties.

Save More Money

Maybe the plans discussed above are just fine for your small business. The fact is, though, that there are solid reasons for establishing plans that allow for higher levels of contributions. That can be beneficial in terms of reducing current taxes and of building greater retirement savings. The downside of these plans is twofold: They have tougher requirements in terms of record keeping and employee participation.

There are three basic alternatives to IRA-based plans: 401(k) plans, profit-sharing plans and defined benefit plans.

By far the most common retirement plan today is the 401(k), which gets its name from the relevant section number of the IRS code. These plans are popular because they allow contributions by both employer and employee and they allow a high level of contributions. Also, unlike the SIMPLE IRA plans, these plans can be used by businesses with more than 100 employees, as well as by smaller employers.

Employees may contribute up to $16,500 annually (and an additional $5,500 for those 50 or older). The employer may also opt to contribute to each employee's retirement account. The maximum allowed combined contributions are the lesser of 100 percent of each employee's compensation or $49,000.

The 401(k) plans have a comprehensive rule for eligibility: You are pretty much required to include everyone who is age 21 or older. And there is a significant new record keeping hurdle: You must pass an annual "non-discrimination test" to make sure that benefits to owners and highly compensated individuals do not exceed established limits.

Finally, you must file an annual return with the IRS for your 401(k) plan, adding to your usual tax overhead headache.

Sail Into Harbor

Do you find an annual discrimination testing too onerous? Or do you have a few highly compensated individuals who want to be able to contribute more to their retirement than what is allowable under the rules of the regular 401(k) plan?

You're not alone. That's why the IRS has established what's called a "Safe Harbor 401(k)." These plans are deemed non-discriminatory and do not require an annual test.

Safe Harbor plans can be great for the small shop with highly compensated owners or managers. The reason is that employees might only want to contribute a small percentage of their salaries. But the owners can put in much more.

Here's the catch: You enjoy your safe harbor by agreeing to a new requirement. You must either match each participating employee's contribution (up to 3 percent of the employee's compensation), or you must make an across-the- board contribution equal to 3 percent of each eligible employee's compensation.

Cover Your Bases

This article has covered only the highlights of each type of retirement plan. You may also want to look into profit sharing plans and defined benefit plans, both of which are more complex to establish and maintain but allow for greater levels of contributions toward retirement.

Bear in mind that employers often maintain more than one type of plan. Whatever route you take, get advice from your accountant and attorney. And consider taking on the assistance of a consultant who specializes in employer-sponsored retirement accounts. Pick one who does not have a vested financial interest in a given plan. "It's not easy to find someone who does not have an axe to grind," says Milberg. "The financial services industry sees retirement plan assets as a pot of gold."

Your advisor should be able to help you file the annual paperwork for those plans requiring it and assure you are making the correct contribution amounts. "Errors are often made with retirement plan designs," says Tracy Davidson, president of Davidson Pension Consulting, Larkspur, Calif. "You need to make sure you understand the rules." Errors, she cautions, can result in costly tax liabilities.

Comments or thoughts on this article? Please e-mail [email protected].

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