Picking the right retirement plan for your business can help you and your employees make worthwhile investments in your financial futures.
You probably didn’t launch your company thinking about retirement plan options — and digging into the intricacies of the tax code to determine the most effective plan isn’t likely to be at the top of your priority list. Still, that effort could pay off. Choosing a solid retirement plan is in your entire company’s best interest, and it may help you attract, motivate, and retain the people who help your business thrive.
While the contribution limits, costs, and other aspects of different retirement plan types can be daunting, you don’t need to focus on particulars right away, says James Purdie, Regional Executive for Regions Institutional Services. “Start with what you want to achieve,” says Purdie, who suggests asking yourself several questions. Are you looking to lead by example, contributing on behalf of your employees? Or, do you want to motivate them to save? How fast is your company growing? Account for those answers, along with other variables, as you weigh the differences among plans.
Simplified Employee Pension (SEP) IRA
If your business is small or you’re the only employee, a SEP IRA allows you to contribute up to a yearly maximum — $57,000 in 2020. You can vary the percentage of your contribution from year to year or skip a year if funds are tight. You have until the extended due date of your tax return to set up a plan and make contributions, so you can calculate your profits before you decide how much to contribute.
Keep in mind, a SEP IRA doesn’t allow your employees to put in their money, and you generally have to contribute the same percentage of everyone’s salary, including yours.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
SIMPLE IRAs are generally a good fit for a business with 100 employees or fewer. With a SIMPLE IRA, your employees can opt to make their own contributions annually — as much as $13,500 in pre-tax earnings (or $16,500 if they’re 50 or older) in 2020. Check the IRS for updated limits.
However, there’s not as much flexibility with this type of retirement plan. You will have to make an employer contribution every year — either pay a flat 2 percent of an employee’s compensation or match an employee’s contribution, up to 3 percent of compensation. If there’s a lull in your business, however, you are allowed to reduce your matching contribution to 1 percent as often as twice in five years.
Individual 401(k)
If you — or you and your spouse — are your only employees, an individual 401(k) lets you set aside as much as $19,500 in pre-tax earnings ($26,000 if 50 or older) plus 25% of compensation, up to a total maximum of $57,000 ($63,500 if 50 or older) for 2020. And you decide how much to contribute. “The only downside is that once assets in the plan exceed $250,000, you’ll need to file an annual report with the IRS,” says Purdie.
Employer-sponsored 401(k)
Companies with any number of employees might consider offering employer-sponsored 401(k) accounts, which use the same contribution limits as individual 401(k)s. With this plan, your employees can decide how much salary to defer and you can choose to contribute an additional amount on their behalf, often a match on a portion of their contributions.
Due to the costs and complexity of setting up and administering an employer-sponsored 401(k), consider working with your wealth advisor and a benefits consultant, who can help you make sure this plan is your best option and meets your goals, Purdie says.
Cash Balance Pension Plan
This plan turns the usual retirement savings process on its head. Rather than looking at how much you and your employees contribute, it starts with the amount of the retirement benefit you want and then calculates what it will take to get there. That goal determines how much your company must contribute. These amounts are likely to exceed contribution limits for other plans by a hefty margin, but can turbocharge savings for owners and their employees.
You’ll need an actuary to generate annual participant statements and to file detailed reports with the IRS. The contribution limits for these plans increase with age, so review the most recent regulations for cash balance plans. Your company, or an investment manager of your choice, is charged with generating sufficient funds to provide the guaranteed benefit amount.
This retirement plan can be a good fit for companies with high-income owners who want to beef up retirement savings quickly. “It’s ideal for physicians, attorneys, engineers, or architects — private groups looking to maximize their tax-deferred savings,” says Purdie, who notes that a cash balance pension plan can be paired with an employer-sponsored 401(k) to allow even greater savings.
Whichever type of plan you choose now, expect to revisit your options within a few years, Purdie says. “You may outgrow your plan and need to step up to something more comprehensive,” he explains. “Then, as now, this process is about defining your goals and identifying the best way to reach them.”
