The decision to implement a retirement plan is one of the smartest choices that a business can make. It can give you and your employees the opportunity to save for your future while enjoying substantial tax savings today. The benefit to a business owner is twofold. First, as a business owner, a company-sponsored retirement plan can help you attract and retain your most valuable business assets – quality employees. Secondly, as a participant, a retirement plan will allow you to save for your own retirement.
Simplified Employee Pension
A Simplified Employee Pension Plan, or SEP, may be an ideal choice for self-employed individuals or small businesses because it is very easy to administer. A SEP can provide many of the benefits of a standard retirement plan, and is easy to establish and maintain. A SEP can also give you more limited responsibility as an employer. Each of your employees is responsible for his or her own SEP-IRA account. This means less administrative hassle for you, and also there is a comparatively small amount of government reporting. The typical candidates for establishing SEP accounts are sole proprietors, consultants, and small businesses — especially those with high turnover rates or younger employees.
How a SEP works
A SEP plan allows for employer contributions of 25% of eligible employee compensation up to $40,000. All of your contributions into a SEP plan are tax deductible. If you have employees, they must be included in the plan as well. You must contribute the same percentage of their earnings as you do personally. All employees who meet the following criteria must be included in the plan:
– Age 21 or higher
– Employed by you for any amount of time during three of the last five years, and
– Received at least $450 of compensation from you in the current year
Profit Sharing & Money Purchase
Qualified Retirement Plans like Profit Sharing and Money Purchase Plans are types of retirement plans that are funded by the employer. They allow employers to contribute to an employee’s account, while offering them business tax deductions and tax-deferred savings.
How the Profit Sharing Plan Works
Profit Sharing Plans are designed for companies with fluctuating or uncertain profits. These plans can be established by sole proprietors, partnerships, or corporations. Companies can make a discretionary contribution of up to 15% of an eligible employee’s total compensation. In a Profit Sharing Plan, the employer has the flexibility to determine the contribution amount each year. Contributions do not have to be dependent on profits. Contributions by the employer are tax deductible as a business expense and are not treated as taxable income to the employee.
How the Money Purchase Plan Works
In Money Purchase Plans, the employer’s contribution is mandatory. The contributions are usually based on each employee’s compensation. The employer sets specific eligibility and vesting requirements, and contributions can be as high as 25% of total compensation up to $40,000. Money Purchase Plans are less flexible than Profit Sharing Plans because contributions must be made even if the company has no profits.
Profit Sharing & Money Purchase Combination
Many companies choose to implement both of these types of plans in conjunction with one another. This allows for a greater total contribution percentage. By combining these two types of plans, an employer can effectively contribute 25%, up to $30,000. A typical example of how this works is an employer making a 10% mandatory Money Purchase contribution, and a discretionary 15% contribution into the Profit Sharing Plan. This type of approach offers some flexibility while maximizing the potential contribution percentage.
SIMPLE IRA Plan
The Savings Incentive Match Plan for Employees-IRA replaced the SARSEP-IRA for plans established after January 1, 1997. A SIMPLE-IRA is specifically designed for companies with less than 100 employees. Companies with more than 100 employees cannot use the SIMPLE Plan. Additionally, companies cannot maintain or contribute into any other type of retirement plan. In a SIMPLE Plan, contributions are made by both employer and employee. Contributions are made on a pre-tax basis, thus giving added tax benefits to the plan’s participants.
How a SIMPLE Plan Works
Employees can contribute 100% of their earned income up to a maximum of $8,000 per year (for 2003) into a SIMPLE Plan. There is a mandatory employer match. This can be either a 100% match on the first 3% of employees’ total compensation for all eligible employees who elect to participate in the plan, or a 2% match on total employee compensation regardless of employee participation. A SIMPLE plan can work great for a family-run business. A husband and wife business can put in up to $32,000 combined depending on their compensation. A SIMPLE Plan offers you and your employees the opportunity to contribute money on a pre-tax basis into a retirement account. SIMPLE Plans are easy to set up and administer, and have minimal administrative costs.
401(k) Plan
The 401(k) Plan is probably the most widely-used company retirement plan. The term 401(k) refers to the section of the Internal Revenue Code which permits employees to defer part of their income into a company-sponsored retirement plan. A 401(k) Plan is a great way to attract and retain employees. 401(k) Plans allow for contributions by both the employee and employer. A profit-sharing contribution can also be made by the employer. This type of contribution is at the discretion of the company. A matching contribution may also be made by the employer on behalf of the employees. This type of contribution is mandatory if that option is selected as a plan feature.
How a 401(k) Plan Works
The flexibility of a 401(k) Plan allows companies to select plan features to achieve specific goals for your company and your employees. A plan must set specific eligibility requirements and vesting schedules. A 401(k) Plan may require that employees be age 21 and/or completed at least one year of employment with the company in order to participate. If the plan calls for immediate vesting, two years of employment may be required prior to becoming eligible.
Vesting is another term for ownership of the account balance and is determined mainly by the source of the funds. Contributions that employees make are always 100% vested, meaning that they always own all of the money that they contribute into the plan. Contributions that employer’s make may follow a schedule in which the vesting percentage increases with each year of employment. The maximum number of years before an employee is fully vested is seven. This is at the employer’s discretion and can be less than seven years.
The maximum amount of annual contributions into a 401(k) Plan is 100% of an employee’s compensation or $17,000 (for 2011). Employee contributions and company matching contributions cannot be more than 25% of an employee’s total compensation. Employers can alter their matching contributions from year to year.