Printer
Friendly Version PDF
Version
Starting a small business retirement savings plan can be easier than
most business people think. What’s more, there are a number of
retirement programs that provide tax advantages to both employers and
employees.
Why Save?
Experts estimate that Americans will need 70 to 90 percent of their
preretirement income to maintain their current standard of living when
they stop working. So now is the time to look into retirement plan
programs. As an employer, you have an important role to play in helping
America’s workers save.
By starting a retirement savings plan, you will help your employees
save for the future. Retirement plans may also help you attract and retain
qualified employees, and they offer tax savings to your business. You will
help secure your own retirement as well. You can establish a plan even if
you are self-employed.
Any Tax Advantages?
A retirement plan has significant tax advantages:
-
Employer contributions are deductible from the employer’s income,
-
Employee contributions are not taxed until distributed to the employee,
and
-
Money in the program grows tax-free.
Any Other Incentives?
In addition to helping your business, your employees, and yourself,
recent tax law changes have made it easier than ever to establish a
retirement plan. They include:
-
Higher contribution limits so your employees (and you) can set aside
even larger amounts for retirement;
-
“Catch-up" rules that allow employees aged 50 and over to set aside
additional contributions. The amount varies, depending on the type of
plan;
-
Tax credit for small employers that would enable them to claim a tax
credit for part of the ordinary and necessary costs of starting a SEP,
SIMPLE, or certain other types of plans (more on these later). The credit
equals 50 percent of the cost to set up and administer the plan, up to a
maximum of $500 per year for each of the first 3 years of the plan;
-
Tax credit for certain low- and moderate-income individuals (including
self-employed) who make contributions to their plans (“Saver’s tax
credit”). The amount of the credit is based on the contributions
participants make and their credit rate. The maximum contribution eligible
for the credit is $2,000. The credit rate can be as low as 10 percent or
as high as 50 percent, depending on the participant’s adjusted gross
income; and
-
A Roth 401(k) program that can be added to a 401(k) plan to allow
participants to make after-tax contributions into separate accounts,
providing an additional way to save for retirement. Distributions upon
death or disability or after age 59½ of amounts held for 5 years in Roth
accounts, including earnings, are generally tax free.
A Few Retirement Facts
Most private-sector retirement vehicles are either Individual
Retirement Arrangements (IRAs), defined contribution (DC) plans or defined
benefit (DB) plans.
People tend to think of an IRA as something that individuals establish
on their own, but an employer can help its employees set up and fund their
IRAs. With an IRA, the amount that an individual receives at retirement
depends on the funding of the IRA and the earnings (or income) on those
funds.
Defined contribution plans are employer-established plans that do not
promise a specific amount of benefit at retirement. Instead, employees or
their employer (or both) contribute to employees’ individual accounts
under the plan, sometimes at a set rate (such as 5 percent of salary
annually). At retirement, an employee receives the accumulated
contributions plus earnings (or minus losses) on such invested
contributions.
Defined benefit plans, on the other hand, promise a specified benefit
at retirement, for example, $1,000 a month at retirement. The amount of
the benefit is often based on a set percentage of pay multiplied by the
number of years the employee worked for the employer offering the plan.
Employer contributions must be sufficient to fund promised benefits.
Small businesses may choose to offer IRAs, DC plans, or DB plans. Many
financial institutions and pension practitioners make available one or
more of these retirement plans that have been pre-approved by the IRS.
|
|
Payroll
Deduction IRA |
SEP |
Simple
IRA Plan |
Key Advantage |
Easy to set up and
maintain. |
Easy to set up and
maintain. |
Salary reduction plan
with little administrative paperwork. |
Employer Eligibility |
Any employer with one or
more employees. |
Any employer with one or
more employees. |
Any employer with 100 or
fewer employees that does not currently maintain another
retirement plan. |
Employer's Role |
Arrange for employees to
make payroll deduction contributions. Transmit
contributions for employees to IRA. No annual filing
requirement for employer. |
May use IRS Form
5305-SEP to set up the plan. No annual filing
requirement for employer. |
May use IRS Forms
5304-SIMPLE or 5305-SEP to set up the plan. No
annual filing requirement for employer. Bank or
financial institution handles most of the paperwork. |
Contributors to the Plan |
Employee contributions
remitted through payroll deduction. |
Employer contributions
only. |
Employee salary
reduction contributions and employer contributions. |
Maximum Annual
Contribution (per participant)
See www.irs.gov/ep
for annual updates. |
$4,000 for 2007; $5,000
for 2008. Additional contributions can be made by
participants age 50 or over up to $1,000 in 2007. |
Up to 25% of
compensation(1) but no more than $45,000 for 2007. |
Employee:
$10,500 in 2007. Additional contributions can be
made by participants age 50 or over up to $2,500 in 2007. Employer:
Either match employee contributions 100% of first 3% of
compensation (can be reduced to as low as 1% in any 2 out
of 5 yrs.); or contribute 2% of each eligible employee's
compensation.(2) |
Contributor's Options |
Employee can decide how
much to contribute at any time. |
Employer can decide
whether to make contributions year-to-year. |
Employee can decide how
much to contribute. Employer must make matching
contributions or contribute 2% of each employee's
compensation. |
Minimum Employee
Coverage Requirements |
There is no
requirement. Can be made available to any employee |
Must be offered to all
employees who are at least 21 years of age, employed by
the employer for 3 of the last 5 years and had
compensation of $500 (for 2007). |
Must be offered to all
employees who have earned income of at least $5,000 in any
prior 2 years, and are reasonably expected to earn at
least $5,000 in the current year. |
Withdrawals, Loans and
Payments |
Withdrawals permitted
anytime subject to federal income taxes; early withdrawals
subject to an additional tax (special rules apply to Roth
IRAs). |
Withdrawals permitted
anytime subject to federal income taxes, early withdrawals
subject to an additional tax. |
Withdrawals permitted
anytime subject to federal income taxes, early withdrawals
subject to an additional tax. |
Vesting
|
Contributions are
immediately 100% vested. |
Contributions are
immediately 100% vested. |
Employee salary
reduction contributions and employer contributions are
immediately 100% vested. |
|
|
|
Safe Harbor 401(k) |
Automatic Enrollment
Safe Harbor 401(k)(3) |
401(k) |
Profit Sharing |
Key Advantage |
Permits high level of salary deferrals by
employees without annual discrimination testing. |
Permits high level of
salary deferrals by employees without annual
discrimination testing (after 2007). |
Permits high level of salary deferrals by employees. |
Permits employer to make large contributions for employees. |
Employer Eligibility |
Any employer with one or more employees. |
Any employer with one or
more employees. |
Any employer with one or more employees. |
Any employer with one or more employees. |
Employer's Role |
No model form to establish
this plan. Advice from a financial institution or
employee benefit advisor may be necessary. A minimum
amount of employer contributions is required. Annual
filing of Form 5500 is required. |
No model form to establish
this plan. Advice from a financial institution or
employee benefit advisor may be necessary. A minimum amount of employer contributions is required. Annual filing of Form 5500 is required. |
No model form to establish
this plan. Advice from a financial institution or
employee benefit advisor may be necessary. Annual filing of Form 5500 is required. Requires annual non-discrimination testing to ensure plan does not discriminate in favor of highly compensated employees. |
No model form to establish
this plan. Advice from a financial institution or
employee benefit advisor may be necessary. Annual filing of Form 5500 is required. |
Contributors to the Plan |
Employee salary reduction
contributions and employer contributions. |
Employee salary reduction
contributions and employer contributions. |
Employee salary reduction contributions and maybe employer contributions. |
Annual employer contribution is discretionary. |
Maximum Annual
Contribution (per participant)
See www.irs.gov/ep
for annual updates. |
Employee:
$15,500 in 2007. Additional contributions can be
made by participants age 50 or over up to $5,000 in 2007. Employer/Employee
Combined: Up to the lesser of 100% of compensation(1)
or $45,000 for 2007. Employer can deduct amounts
that do not exceed 25% of aggregate compensation for all
participants. |
Employee:
See annual update for 2008 dollar limit. Additional contributions can be
made by participants age 50 or over. Employer/Employee
Combined: Up to the lesser of 100% of compensation or the dollar limit for 2008 (see annual update). Employer can deduct amounts
that do not exceed 25% of aggregate compensation for all
participants. |
Employee:
$15,500 in 2007. Additional contributions can be
made by participants age 50 or over up to $5,000 in 2007. Employer/Employee
Combined: Up to the lesser of 100% of compensation(1)
or $45,000 for 2007. Employer can deduct amounts
that do not exceed 25% of aggregate compensation for all
participants. |
Up to the lesser of 100% of compensation(1) or $45,000 for 2007. Employer can deduct amounts that do not exceed 25% of aggregate compensation for all participants. |
Contributor's Options |
Employee can decide how
much to contribute pursuant to a salary reduction
agreement. The employer must make either specified
matching contributions or a 3% contribution to all
participants. |
Employees, unless they opt otherwise, 3% salary reduction contributions, with automatic annual increases for 3 years. The employer must make either specified
matching contributions or a 3% contribution to all
participants. |
Employee can decide how much to contribute pursuant to a salary reduction agreement. The employer can make additional contributions, including matching contributions as set by plan terms. |
Employer makes contribution as set by plan terms. Employee contributions, if allowed, as set by plan terms. |
Minimum Employee
Coverage Requirements |
Generally, must be offered
to all employees at least 21 years of age who worked at
least 1,000 hours in a previous year. |
Generally, must include all employees who have not already opted out and who are at least 21 years of age who worked at least 1,000 hours in a previous year. |
Generally, must be offered
to all employees at least 21 years of age who worked at
least 1,000 hours in a previous year. |
Generally, must be offered
to all employees at least 21 years of age who worked at
least 1,000 hours in a previous year. |
Withdrawals, Loans and
Payments |
Withdrawals permitted after
a specified event occurs (e.g., retirement, plan
termination, etc.) subject to federal income taxes.
Plan may permit loans and hardship withdrawals; early
withdrawals subject to an additional tax. |
Withdrawals permitted after
a specified event occurs (e.g., retirement, plan
termination, etc.) subject to federal income taxes.
Plan may permit loans and hardship withdrawals; early
withdrawals subject to an additional tax. |
Withdrawals permitted after
a specified event occurs (e.g., retirement, plan
termination, etc.) subject to federal income taxes.
Plan may permit loans and hardship withdrawals; early
withdrawals subject to an additional tax. |
Withdrawals permitted after
a specified event occurs (e.g., retirement, plan
termination, etc.) subject to federal income taxes. Plan may permit loans and hardship withdrawals; early
withdrawals subject to an additional tax. |
Vesting
|
Employee salary reduction
contributions and most employer contributions are
immediately 100% vested. Some employer contributions may
vest over time according to plan terms. |
Employee salary reduction
contributions vest immediately and most employer contributions must be 100% vested after 2 years of service. Some employer contributions may vest over longer period according to plan terms. |
Employee salary reduction contributions are immediately 100% vested. Employer contributions may vest over time according to plan terms. |
May vest over time according to plan terms. |
-
Maximum compensation on
which 2007 contribution can be based is $225,000.
-
Maximum compensation on
which 2007 employer 2% non-elective contributions can
be based is $225,000.
-
After 2007.
|
|
|
Key Advantage |
Provides a fixed,
pre-established benefit for employees. |
Employer Eligibility |
Any employer with one or
more employees. |
Employer's Role |
No model form to establish
this plan. Advice from a financial institution or
employee benefit advisor would be necessary. Annual
filing of Form 5500 is required. An actuary must
determine annual contributions. |
Contributors to the Plan |
Primarily funded by
employer. |
Maximum Annual
Contribution (per participant)
See www.irs.gov/ep
for annual updates. |
Annually determined
contribution. |
Contributor's Options |
Employer generally required
to make contribution as set by plan terms. |
Minimum Employee
Coverage Requirements |
Generally, must be offered
to all employees at least 21 years of age who worked
at least 1,000 hours in a previous year. |
Withdrawals, Loans and
Payments |
Payment of benefits after a
specified event occurs (e.g. retirement, plan termination,
etc.). Plan may permit loans; early withdrawals
subject to an additional tax. |
Vesting
|
May vest over time
according to plan terms. |
|
Payroll Deduction IRAs
Even if an employer does not want to adopt a retirement plan, it can
allow its employees to contribute to an IRA through payroll deductions,
providing a simple and direct way for eligible employees to save. The
decision about whether to contribute, and when and how much to contribute
to the IRA (up to $4,000 for 2007, $5,000 in 2008, increasing thereafter)
is always made by the employee in this type of arrangement.
Many individuals eligible to contribute to an IRA do not. One reason is
that some individuals wait until the end of the year to set aside the
money and then find that they do not have sufficient funds to do so.
Payroll deductions allow individuals to plan ahead and save smaller
amounts each pay period. Payroll deduction contributions are
tax-deductible by an individual, to the same extent as other IRA
contributions.
Simplified Employee Pensions (SEPs)
A SEP allows employers to set up a type of IRA for themselves and each
of their employees. Employers must contribute a uniform percentage of pay
for each employee, although they do not have to make contributions every
year. For the year 2007, employer contributions are limited to the lesser
of 25 percent of pay or $45,000. (Note: the dollar amount is indexed for
inflation and will increase.) Most employers, including those who are
self-employed, can establish a SEP.
SEPs have low start-up and operating costs and can be established using
a two-page form. And you can decide how much to put into a SEP each year
– offering you some flexibility when business conditions vary.
SIMPLE IRA Plan
This savings option is for employers with 100 or fewer employees and
involves a type of IRA.
A SIMPLE IRA plan allows employees to contribute a percentage of their
salary each paycheck and requires employer contributions. Under SIMPLE IRA
plans, employees can set aside up to $10,500 in 2007 by payroll deduction.
For years after 2007, annual cost-of-living updates can be found at
www.irs.gov/ep. 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.
SIMPLE IRA plans are easy to set up. You fill out a short form to
establish a plan and ensure that SIMPLE IRAs (to hold contributions made
under the SIMPLE IRA plan) are set up for each employee. A financial
institution can do much of the paperwork. Additionally, administrative
costs are low.
Employers may either have employees set up their own SIMPLE IRAs at a
financial institution of their choice or have all SIMPLE IRAs maintained
at one financial institution chosen by the employer.
Employees can decide how and where the money will be invested, and keep
their SIMPLE IRAs even when they change jobs.
401(k) Plans
401(k) plans have become a widely accepted retirement savings vehicle
for small businesses. Today, an estimated 44 million American workers
participate in 401(k) plans that have total assets of about $2.5 trillion.
With a traditional 401(k) plan, employees can choose to defer a portion
of their salary. So instead of receiving that amount in their paycheck
today, the employee can contribute such amount into a 401(k) plan
sponsored by their employer. These deferrals are accounted separately for
each employee. Generally, the deferrals (plus earnings) are not taxed by
the federal government or by most state governments until distributed.
401(k) plans can vary significantly in their complexity. However, many
financial institutions and other organizations offer prototype 401(k)
plans, which can greatly lessen the administrative burden on individual
employers of establishing and maintaining such plans.
Safe Harbor 401(k) Plans
A safe harbor 401(k) plan is intended to encourage plan participation
among rank-and-file employees and to ease administrative burden by
eliminating the tests ordinarily applied under a traditional 401(k) plan.
This plan is ideal for businesses with highly compensated employees whose
contributions would be limited in a traditional 401(k) plan.
A safe harbor 401(k) plan allows employees to contribute a percentage
of their salary each paycheck and requires employer contributions. In a
safe harbor 401(k) plan, the mandatory employer contribution is always 100
percent vested.
Automatic Enrollment Safe Harbor 401(k) Plans
Beginning in 2008, automatic enrollment safe harbor 401(k) plans can
increase plan participation among rank-and-file employees and ease
administrative burden by eliminating the tests ordinarily required under a
traditional 401(k) plan. This plan is for employers who want a high level
of participation, and also have highly compensated employees whose
contributions might be limited under a traditional plan.
All employees are automatically enrolled in the plan and contributions
are deducted from their paychecks, unless they opt out after receiving
notice from the plan. There are set employee contribution rates, which
rise incrementally over the first few plan years, although different
amounts can be chosen. Employer contributions are also required. In
addition, there is a safe harbor for the default investment options
provided under the plan that relieves the employer from liability for the
investment results. Where contributions are invested in automatic
enrollment plans, state payroll withholding law is preempted, so plans may
automatically deduct contributions from employees’ wages unless they opt
out.
Profit-Sharing Plans
Employer contributions to a profit-sharing plan are discretionary.
Depending on the plan terms, there is often no set amount that an employer
needs to contribute each year.
If you do make contributions, you will need to have a set formula for
determining how the contributions are allocated among plan participants.
The funds are accounted separately for each employee.
As with 401(k) plans, profit-sharing plans can vary greatly in their
complexity. Similarly, many financial institutions offer prototype
profit-sharing plans that can reduce the administrative burden on
individual employers.
Defined Benefit Plans
Some employers find that defined benefit (DB) plans offer business
advantages. For instance, employees often value the fixed benefit provided
by this type of plan. In addition, employees in DB plans can often receive
a greater benefit at retirement than under any other type of retirement
plan. On the employer side, businesses can generally contribute (and
therefore deduct) more each year than in defined contribution plans.
However, defined benefit plans are more complex and, thus, more costly to
establish and maintain than other types of plans.
To Find Out More…
The following jointly developed publications are available for small
businesses on the DOL and IRS Web sites and through the toll-free numbers
listed below:
-
401(k) Plans for Small Businesses (Publication 4222)
-
Payroll Deduction IRAs for Small Businesses (Publication 4587)
-
SIMPLE IRA Plans for Small Businesses (Publication 4334)
-
SEP Retirement Plans for Small Businesses (Publication 4333)
-
Retirement Plan Correction Programs (Publication 4224)
-
Retirement Plan Correction Programs CD-ROM (Publication 4050)
DOL Web site: www.dol.gov/ebsa
Publications request number: 1.866.444.EBSA (3272)
IRS Web site: www.irs.gov/ep
Tax form and publication ordering number: 1.800.TAX-FORM
(1.800.829.3676)
(You can place your order 24 hours a day, 7 days a week.)
Also available from the U.S. Department of Labor:
-
Meeting Your Fiduciary Responsibilities
-
Understanding Retirement Plan Fees and Expenses
-
Small Business Retirement Savings Advisor: www.dol.gov/elaws/pwbaplan.htm
Also available from the Internal Revenue Service:
-
Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and
Qualified Plans)
-
Publication 590, Individual Retirement Arrangements (IRAs)
-
Publication 4530, Designated Roth Accounts under a 401(k) or 403(b)
Plan
This pamphlet and other EBSA publications are available by calling
toll-free: 1.866.444.EBSA (3272) or by viewing them on the Internet at: www.dol.gov/ebsa.
It is also available from the IRS by calling: 1.800.TAX FORM (1.800.829.3676).
Please indicate publication number 3998 or catalog number 34066S when
ordering.
This material is also available to sensory-impaired individuals upon
request. Voice Phone: 1.202.219.8921, TDD phone 1.800.326.2577.
|