As an entrepreneur, odds are you're spending more time thinking about stepping into your business than stepping out of it and entering retirement. Though it might be difficult to focus right now on when you or your employees are going to retire, spending a bit of time to set up a small business retirement plan can have huge advantages in the future.
Small business owners do have some choices when it comes to deciding on the right retirement plan for you and your employees. We’ll walk you through the options here so you can choose the one that best supports you and your staff.
Benefits of a Small Business Retirement Plan
Small business retirement plans are designed to provide maximum benefits to you as an employer and to your employees. Some of these benefits include:
- Providing income after retirement
- Simple to setup and administer
- Generous contribution limits for both employers and employees
- Employer contributions are tax deductible
- Employee contributions are not taxed until money is withdrawn from the plan (except Roth plans)
- Money invested in the plan grows tax-free
- Employees over the age of 50 can take advantage of special rules to contribute more
- Tax credits can cover part of the cost of setting up a retirement plan
- “Savers” tax credit for employees on low incomes who make retirement plan contributions
- Roth plans can be added to 401(k) retirement plans to allow after-tax income to be invested in retirement.
As you can see, there are substantial benefits to starting a small business retirement plan. Your employees will also appreciate being able to save for retirement, which can help you attract and retain high-quality, engaged workers.
The main benefit to your business’s bottom line is the tax advantage: There is no tax on employer contributions, and if you contribute to a traditional plan as an employee, you won’t be taxed until you take the money out.
You can start a small business retirement plan as an LLC, S-Corporation, C-Corporation or sole proprietorship.
How to Set Up a Retirement Plan for Your Employees
Though it may seem daunting at the beginning, the sooner your start the process of researching and implementing a small business retirement plan, the better off you will be. Here's how to do it:
1. Choose a Retirement Plan
Small business retirement plans generally fall into one of the following three broad categories: IRA-Based Plans, Defined Contribution Plans, and Defined Benefit Plans. Each of these types contains several specific retirement plan options. We’ll cover a little more on each of those further on, together with some more key facts and benefits of each.
IRA-Based Plans
The IRA is one of the most common types of small business retirement plans. Individuals can set up this plan on their own, but sometimes an employer will offer assistance. The individual and employer can both make contributions, and the amount available at retirement is based on the total contributed and the investment growth of these funds over time.
Payroll Deduction IRA
In a payroll deduction IRA, employees can contribute to their retirement account directly from their paychecks. The employee can choose how much, how often and whether they want to contribute to the IRA. This is a common option for most corporate jobs. Here are some benefits to a payroll deduction IRA:
- Easy to start and maintain; employers just need to arrange and transmit IRA contributions
- Any employer with one or more employees can start a payroll deduction IRA
- There is no annual filing requirement
- Maximum annual contribution is $5,500 up to age 50 and $6,500 after age 50
- The employee can decide how much they want to contribute
Simplified Employee Pensions (SEP)
The SEP plan allows employers to set up pension plans for their employees. Employers normally provide a uniform percentage of pay to a SEP plan.
- Easy to start and maintain; employers need to use form 5305-SEP to set up the plan
- Only employers contribute to a SEP plan (not employees); employers choose how much they want to contribute on a year-to-year basis
- They can contribute up to 25 percent of compensation, but not more than $53,000
SIMPLE IRA Plan
This plan allows employees to contribute a percentage of their salary to an IRA each paycheck, and it also requires employer contributions. Employers must either match employee contributions dollar for dollar (up to 3 percent of an employee’s compensation) or make a fixed contribution of 2 percent of compensation for all eligible employees (even if the employees choose not to contribute).
- There is some administrative paperwork involved in setting up a SIMPLE plan using forms 5304-SIMPLE or 5305-SIMPLE
- Any employer with 100 or fewer employees who do not offer other retirement plans can offer the SIMPLE IRA plan
- Both employees and employers contribute to this plan
- Employees can contribute up to $12,500 a year; employer matches the first 3 percent of compensation
Defined Contribution Plans
Defined contribution plans are set up by an employer and include the commonly-used 401(k). These plans do not promise a specific amount at retirement; instead, an employee commits to funneling a certain amount of their salary into the plan on a regular basis. Employers can also contribute. When an employee retires, they receive the contributions they have made, adjusted for any investment gains or losses.
Traditional Small Business 401(k)
With this type of plan, an employee can choose to defer a portion of their salary and pay it into the retirement plan, where it will be invested and grow over time. Instead of receiving that amount in their paycheck today, the employees can contribute it to a 401(k) plan sponsored by their employer. These deferrals are accounted separately for each employee.
Small Business Safe Harbor 401(k)
A safe harbor plan is meant to encourage employees to begin contributing to a retirement plan and ease the administrative burden of setting up and managing a plan. This plan is best suited to businesses with well-paid employees who want to make the most of their contributions.
- No specific form required, but it is recommended that you take advice from a financial adviser, institution or employee benefit expert
- Both employees and employers can make contributions to the safe harbor 401(k)
- Employees can contribute up to $18,000 a year up to the age of 50, and $24,000 over the age of 50
- The employer and employee combined contribution can be up to the lesser of total compensation or $53,000
- The employee can decide how much to contribute based on a salary reduction agreement
- The employer must make either specified matching contributions or a 3 percent contribution to all participants
Small Business Automatic Enrollment 401(k)
These plans automatically enroll employees and are set up to make automatic deductions from their paychecks unless they opt out of contributing after receiving notice from the plan. There are standard employee contribution rates, although the employee can choose different amounts.
Defined Benefit Plans
Some employers might prefer defined benefit plans for their employees. Typically, employers can often contribute (and therefore deduct) more with a defined benefit plan than a defined contribution plan.
Employees also appreciate the certainty provided by a defined benefit plan. However, defined benefit plans are often more complex and expensive to set up and manage than other types of plans.
Due to the complexity of defined contribution and defined benefit plans, it's good to speak to a financial adviser to learn how to set one up for your business.
Standard and Roth Plans — What It Means for Taxes
In almost all cases, employer contributions to employee retirement plans are tax deductible. However, the way employees are taxed on retirement plans does differ.
With a standard retirement plan, employees are not taxed on any income they contribute to the plan — that income is effectively tax deferred. However, they are taxed when they withdraw money from the plan, hence the tax is deferred until later.
With a Roth plan, an employee contributes income that has already been taxed. This means there is no additional tax deducted when the retiree withdraws money from the plan later.
Employees should speak with a financial adviser to understand the likely impact of investing in standard versus Roth plans; sometimes a combination of the two can be the best choice.
2. Consult with a Financial Professional
When it comes to setting up your retirement plan, it's best to speak with your accountant and/or financial adviser to learn which plan would be best for you, your business and your employees. These professionals can also help you complete all the necessary paperwork so you can offer a retirement plan that works for everyone and keeps employees happy.
If you need to legally set up your business so you can get your retirement plan in place, Incfile is a great place to start. We can help you decide which business entity will be best for your company and then file the appropriate paperwork on your behalf.
Paul Maplesden
Paul is a freelance writer, small business owner, and British expat exploring the U.S. When he’s not politely apologizing, he enjoys hats, hockey, Earl Grey Tea, mountains, and dogs.
