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Choosing A Retirement Solution For Your Small Business

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Starting a retirement savings plan can be easier than most business owners 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 (other than Roth contributions) are not taxed until distributed to the employee, and
• Money in the plan grows tax-free.

Any Other Incentives?

In addition to helping your business, your employees and yourself, it is easy to establish a retirement plan, and there are additional reasons for doing so:

• High contribution limits so your employees (and you) can set aside large 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 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 from Roth accounts held for 5 years, including earnings, are generally tax-free.

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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 losses) 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 the 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 retirement plan practitioners make available one or more of these retirement plans that have been pre-approved by the IRS.

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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 employees to save. The decision about whether to contribute, and when and how much to contribute to the IRA (up to $5,000 in 2010 and 2011, $6,000 if age 50 or older, 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.

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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. Employer contributions are limited to the lesser of 25 percent of pay or $49,000 in 2010 and 2011. (Note: the dollar amount is indexed for inflation and may 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.

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SIMPLE IRA Plans

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 $11,500 in 2010 and 2011, $14,000 if age 50 or older, by payroll deduction. For years after 2011, annual cost-of-living updates can be found at www.irs.gov/retirement. 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.

If the plan provides for it, employers can choose to automatically enroll employees in SIMPLE IRA plans as long as the employees are allowed to choose not to have salary reduction contributions made to their SIMPLE IRAs or to have salary reduction contributions made in a different amount.

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.

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401(k) Plans

401(k) plans have become a widely accepted retirement savings vehicle for small businesses. Today, an estimated 60 million American workers have employer-based 401(k) plans that have total assets of about $2.8 trillion.

With a 401(k) plan, employees can choose to defer a portion of their salary. So instead of receiving that amount in their paycheck today, the employees can contribute the amount into a 401(k) plan sponsored by their employer. These deferrals are accounted separately for each employee. Deferrals are made on a pretax basis but if the plan allows, they can be made on an after-tax (Roth) basis at the employee's choosing.  Many 401(k) plans provide for employer matching or other contributions.  Employer contributions and pretax 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 these plans.

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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.

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Automatic Enrollment 401(k) Plans

Automatic enrollment 401(k) plans can increase plan participation among rank-and-file employees and make it more likely the plan will pass the tests ordinarily required under a traditional 401(k) plan. Some automatic enrollment 401(k) plans are exempt from the testing.  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 401(k) plan.

Employees are automatically enrolled in the plan and contributions are deducted from their paychecks, unless they opt out of contributing after receiving notice from the plan. There are default employee contribution rates, which may rise incrementally over the first few plan years, although different amounts can be chosen. In addition, for certain default investment options provided under the plan, there is relief from liability for the investment results.

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Profit Sharing Plans

Employer contributions to a profit sharing plan can be 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.

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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, DB plans are more complex and likely more expensive to establish and maintain than other types of plans.

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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)
• Automatic Enrollment 401(k) Plans for Small Businesses (Publication 4674)
• Payroll Deduction IRAs for Small Businesses (Publication 4587)
• Profit Sharing Plans for Small Businesses (Publication 4806)
• SIMPLE IRA Plans for Small Businesses (Publication 4334)
• SEP Retirement Plans for Small Businesses (Publication 4333)

And for business owners with plans:

• Adding Automatic Enrollment to Your 401(k) Plan (Publication 4721)
• Retirement Plan Correction Programs (Publication 4224)

DOL Web site: www.dol.gov/ebsa
Publications request number: 1-866-444-3272

IRS Web site: www.irs.gov/retirement
Tax form and publication ordering number: 1-800-TAX FORM (829-3676)
(You can place your order 24 hours a day, 7 days a week.)

Also available from the U.S. Department of Labor

Two interactive Web sites to help you find the appropriate plan option(s) for you

• Small Business Retirement Savings Advisor: www.dol.gov/elaws/pwbaplan.htm
• Interactive Web site with the American Institute of Certified Public Accountants (AICPA): www.choosingaretirementsolution.org

Publications for Plan Officials:

• Meeting Your Fiduciary Responsibilities
• Understanding Retirement Plan Fees and Expenses
• Selecting and Monitoring Pension Consultants - Tips for Plan Fiduciaries
• Tips for Selecting and Monitoring Service Providers for Your Employee Benefit Plan

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
• Retirement Plans Navigator, a Web guide for choosing a retirement plan, maintaining it and correcting plan errors

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Footnotes

1. Maximum compensation on which 2010 and 2011 contribution can be based is $245,000.
2. Maximum compensation on which 2010 and 2011 employer 2% non-elective contributions can be based is $245,000.

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This pamphlet is a joint project of the U.S. Department of Labor's Employee Benefits Security Administration (EBSA) and the Internal Revenue Service.  Its publication does not constitute legal, accounting, or other professional advice.  It does, however, constitute a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.

This pamphlet and other EBSA publications are available by calling toll free 1-866-444-3272 or by viewing them on the Internet.  It is also available from the IRS by calling 1-800-TAX FORM (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: (202) 693-8664, TDD Phone: (202) 501-3911.