Choosing the right small business retirement plan for your employees
In today's job market, a qualified retirement plan can help a small business be competitive with other (perhaps larger) companies that offer such plans. Small business clients often need help from their tax professional in choosing a retirement plan. While there is no one-size-fits all approach to selecting the right plan, determining the client’s goals is an important first step. Goals may range from simply providing employees a vehicle for retirement savings to maximizing contributions for the owners and other highly compensated or key employees. Here are some tips on choosing the right plan to meet various client goals.
Select between various retirement plan types
Businesses can choose from IRA-based plans, defined contribution plans, or defined benefit (traditional pension) plans. IRA-based plans include payroll deduction IRAs, SEPs (Simplified Employee Pensions), and SIMPLE IRA Plans. Defined contribution plans include profit-sharing plans, safe harbor 401(k) plans, automatic enrollment 401(k) plans, SIMPLE 401(k) plans, and traditional 401(k) plans.
Consider the employer and employee contribution of each plan type
IRA-based plans are easy to set up and maintain, while defined contribution plans generally allow small business owners the ability to provide a higher level of savings for their employees. Distinguishing features of different plan types include the following.
- With a payroll deduction IRA plan, the employee controls the decision of whether, when, and how much to contribute to their IRA (up to $6,000 for 2021, and $7,000 if age 50 or older).
- A SEP plan allows employers to contribute a uniform percentage of pay for each employee. Employer contributions are limited to the lesser of 25% of compensation or $58,000 for 2021.
- Under a SIMPLE IRA plan, employees may save $13,500 in 2021, plus an additional $3,000 if age 50 or older. Employers must either match employee contributions up to 3% of compensation or make a fixed contribution of 2% of compensation for all eligible employees, even if the employees choose not to contribute.
- Employer contributions to a profit-sharing plan can be discretionary. 401(k) plans allow employees to contribute up to $19,500 in 2021, and if age 50 or over an additional contribution of $6,500 can be made for 2021.
Factor in your employer obligations
These include the amount and timing of required employer contributions, the provision of benefits under the plan, and the employer's desired tax deductions.
Align your long-term employer benefits
Small business owners often find qualified retirement plans attractive because, like salaries, contributions to these plans are deductible. However, each employer has different goals to accomplish in choosing a retirement plan. The tax professional should assist their client in identifying and understanding the client's objectives for their retirement plan. Too often, the selection of a qualified retirement plan is driven by the short-term objective of creating a current-year deduction, without a thorough understanding by the client of all the factors involved in selecting an appropriate retirement plan.
Review the most popular small business retirement plans
The table below can be used to meet various employer goals. For quick answers to the many questions on the ins and outs of retirement plans for small businesses and individuals, consider the IRA and Retirement Plan Quickfinder Handbook.
|Employer Goal||Defined benefit||Profit sharing||401(k)||Simple 410 (k)||SEP||Simple IRA||Payroll Deduction IRA|
Maximize tax deductions
Increase employee incentive
Control benefit costs
|Maximize contributions or benefits to highly compensated employees||X2||X3||X3||X4|
|Attract and retain valuable employees||X||X||X||X||X||X||X|
|Allow employee pre-tax||X||X||X|
|Flexibility in making contributions||X||X||X||X|
Minimize cost of adopting
Minimize administration costs
Maintain competitive benefits
Provide retirement income
1 Self-employed individuals, in certain cases, may be able to use a SIMPLE IRA to maximize contributions.
2 Benefits older, longer-service participants.
3 Permitted disparity (greater benefits for employees earning more than the social security taxable wage base) and age-weighted (consideration of both age and compensation in determining employer contribution allocations to participants) features allowed. For 401(k) plans, designated Roth accounts are allowed, which include employee contributions in income but exclude qualified distributions from income.
4 Permitted disparity allowed for non-model SEPs.
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