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Employer Considerations(section
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Small Business
Retirement Plan Options
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There are several types of retirement plans to choose from, and each type of plan has advantages and disadvantages. This discussion
covers the most popular plans. You should also know that the law permits you to have more than one retirement plan and with
sophisticated planning, a combination of plans might best suit your business's needs.
Profit-sharing plans
Profit-sharing plans are among the most popular employer-sponsored
retirement plans. These straightforward plans allow you, as an employer, to make a contribution that is spread among the plan
participants. You are not required to make an annual contribution in any given year. However, contributions must be made on
a regular basis.
With a profit-sharing plan, a separate account is established for each plan participant, and contributions
are allocated to each participant based on the plan's formula (this formula can be amended from time to time). As with all
retirement plans, the contributions must be prudently invested. Each participant's account must also be credited with his
or her share of investment income (or loss).
401(k) plans
A type of deferred compensation plan and the most popular type of plan by far, the 401(k) plan allows contributions to be
funded by the participants themselves, rather than by the employer. Employees elect to forgo a portion of their salary and
have it put in the plan instead.
The requirements for 401(k) plans are complicated, and several tests must be met
for the plan to remain in force. For example, the higher paid employees' deferral percentage cannot be disproportionate to
the rank-and-file's percentage of compensation deferred.
These plans can be extremely expensive to administer, but
the employer's contribution cost is generally very small (employers often offer to match employee deferrals as an incentive
for employees to participate). Thus, in the long run, 401(k) plans tend to be relatively inexpensive for the employer.
401(k) plans
(For the Self Employed)
An individual
401(k) plan is a regular 401(k) plan combined with a profit-sharing plan. However, it can only be implemented by self-employed
individuals or small business owners who have no other full-time employees (an exception applies if your full-time employee
is your spouse). An individual 401(k) plan isn't really a different kind of 401(k) plan. It just takes advantage of relaxed
rules when the only participants in the plan are the owner and the owner's spouse.
Money purchase pension plans
Similar to profit-sharing plans, but employers are
required to make an annual contribution. Participants receive their respective share according to the plan document's formula.
As with profit-sharing plans, money purchase pension plans cap individual contributions at 100 percent of earnings or
$44,000 annually, while employers are allowed to make deductible contributions up to 25 percent of the total compensation
of all plan participants.
Like profit-sharing plans, money purchase pension plans are relatively straightforward
and inexpensive to maintain. However, they are less popular than profit-sharing or 401(k) plans because of the annual contribution
requirement.
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Employer Considerations
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Defined benefit plans
By far the most sophisticated type of retirement plan, a defined benefit program sets out a formula that
defines how much each participant will receive annually after retirement if he or she works until retirement age. This is
generally stated as a percentage of pay, and can be as much as 100 percent of final average pay at retirement.
An actuary certifies how much will be required each year to fund the projected retirement
payments for all employees. The employer then must make the contribution based on the actuarial determination. In 2006, the
maximum annual retirement benefit an individual may receive is $175,000 or 100 percent of final average pay at retirement.
Unlike defined contribution plans, there is no limit on the contribution. The employer's total contribution is based
on the projected benefits. Therefore, defined benefit plans potentially offer the largest contribution deduction and the highest
retirement benefits to business owners.
Savings Incentive
Match Plan for Employees
A sophisticated individual retirement account, the Savings Incentive Match Plan
(SIMPLE) allows employees to contribute to an IRA. In addition, employees age 50 and over may make "catch-up" contributions.
Employers are required to match deferrals, up to 3 percent of the contributing employee's wages (or make a fixed contribution
of 2 percent to the accounts of all participating employees whether or not they defer to the plan).
These plans
work much like 401(k) plans, but do not have all the testing requirements. So, they're cheaper to maintain. There are several
drawbacks, however. First, all contributions are immediately vested, meaning any money contributed by the employer immediately
belongs to the employee (employer contributions are usually "earned" over a period of years in other retirement plans). Second,
the amount of contribution highly paid employees can receive is severely limited compared to other plans. Finally, the employer
cannot have more than 100 employees or maintain any other retirement plan.
Simplified Employee Pension
A written plan that allows employers to make retirement
contributions to individual retirement accounts (called SEP-IRAs) set up for each eligible plan participant. These contributions
may be deducted from the business's income and excluded from the employee's income.
In
addition, eligible employees can also make contributions to their SEP-IRA accounts. Although SEP-IRAs
can accept higher annual contributions than traditional IRAs, SEP-IRAs are subject to the same procedures and federal income
tax rules that apply to traditional IRAs.
Finding a plan that's right for you
The above sections are not exhaustive, but represent the most popular
plans in use today. Recent tax law changes have given retirement plan professionals new and creative ways to write plan formulas
and combine different types of plans in order to maximize contributions and benefits for higher paid employees.
If
you are considering a retirement plan for your business, we can help determine what works best for you and your business
needs. The rules regarding employer-sponsored retirement plans are very complex and easy to misinterpret. In addition, even
after you've decided on a specific type of plan, you will often have a number of options in terms of how the plan is designed
and operated. These options can have a significant and direct impact on the number of employees that have to be covered, the
amount of contributions that have to be made, and the way those contributions are allocated
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