Retirement Savings: Which Option is Best for your Business?
Employee attraction and retention play a crucial role in the success and sustainability of a business. One of the best tactics to ensure employee retention is to offer competitive benefits, including an enticing retirement plan.
Employee retirement plans come in several different forms, and every business is unique. Therefore, there is not a single best answer. Choosing which retirement plan is best for your small business is highly individualized and begins with understanding the various options available. Below, we will compare four of the most common retirement benefit plans.
401(k)
A 401(k) is a tax-advantaged retirement savings plan that is provided to the employee by the employer. Any investment earnings are not taxed until the funds are withdrawn, typically after retirement. The IRS considers a 401(k) to be a defined-contribution plan where employees contribute a defined amount through automatic payroll withholdings. In most cases, the employer will offer contributions through a matching program.
It is the employer's responsibility to manage the administrative work of deducting the contributions, depositing them to the designated 401(k) account, and contributing any matching or other contributions as outlined in the plan.
Employer Considerations
● Employers are able to deduct 401(k) contributions on the company's federal income tax in accordance with limitations set by the IRS.
● Investment gains and elective deferrals are not taxed until distribution.
● A tax credit of up to $16,500 is available for the first three years and can be applied to startup expenses.
● A 401(k) also acts as a great talent acquisition tool, attracting potential employees.
● There are many different types of 401(k) plans to choose from. All can be found on the IRS website.
Employee Considerations
● Employees save based on the pre-taxed dollar amount while they are working. It is anticipated that once the funds are pulled for retirement, the employee will be in a lower tax bracket, generating even more savings.
● Employers have the option to match a percentage of the employee's contributions.
● Vesting depends on the employer.
Limitations
● The annual maximum employee contribution is $22,500 for 2023.
● The combined employee and employer contribution limit is $66,000.
● Employees 50 and older are allowed an additional $7,500 in catch-up contributions. This raises the employee contribution to $30,000.
Simple IRA Plans
Business owners with 100 or fewer employees may opt to offer a Simple IRA plan. Similar to a 401(k), both employers and employees contribute to the retirement savings plan. However, employees contribute based on pre-taxed amounts, and the employers are required to match up to 3% or a nonelective contribution of 2% for each eligible employee. With a Simple IRA, employees cannot opt out of the simple IRA if they are eligible.
Employer Considerations
● A tax credit is available for the first three years, equal to 50% of startup costs, up to $500 each year.
● Simple IRAs are less expensive and easier to set up compared to other "qualified plans."
● Contributions are inflexible.
● There is no employer filing requirement.
● There are no requirements for discrimination testing.
● The employer can't have another retirement plan.
Employee Considerations
● Employer contributions are immediately vested.
● Contributions reduce taxable income. Investments grow tax-deferred, and withdrawals in retirement are taxed as typical income.
● Simple IRAs have a large menu of investments to choose from. Other plans are typically more limited.
● Typically a 10% additional tax applies to any withdrawals made before the age of 59.5. If a withdrawal occurs within two years, the additional tax is increased to 25%
Limitations
● The annual maximum employee contribution is $15,500.
● Employees 50
and older are allowed an additional $3,500 in catch-up contributions. This
raises the employee contribution to $19,000.
Profit-Sharing Plans
A profit-sharing plan is a unique retirement savings plan that allows employers to reward qualified employees based on their performance. These plans may be utilized by any size business and can be offered in addition to other retirement account plans.
With profit-sharing plans, eligible employees receive quarterly or annual contributions from their employer. However, these employer contributions are the only contributions made into these accounts.
Employer Considerations
● Profit-sharing plans allow for year-to-year flexibility regarding how and when contributions are made.
● Profit-sharing plans increase productivity and encourage loyalty of employees, as they are based on performance.
● Contributions up to 25% of the employee's salary can be made and are tax deductible.
● Employers must annually file a Form 5500.
● Testing for discrimination is required.
Employee Considerations
● Profit-sharing plans may be additional to other retirement plans.
● Withdrawals are subject to a potential 10% added tax if under the age of 59.5
Limitations
● The maximum employer contribution limit is less than 100% of compensation or $66,000.
Cash Balance Plans
A cash balance plan is sometimes referred to as a hybrid plan. It is a qualified, tax-favored retirement savings plan resembling a 401(k) in terms of portability and defined contributions. However, these plans utilize different investment principles and allow for significantly higher contributions. With a cash balance plan, it is the employer's responsibility to annually contribute a set percentage of the employee's salary to the account.
Employer Considerations
● Contributions are deductible as an above-the-line tax deduction, reducing the income dollar for dollar.
Employee Considerations
● Contribution limits are high and depend on age. Older employees can make larger contributions, which can dramatically increase the retirement fund in a short period of time.
● Lump sum payouts are available.
● Cash Balance Plans can be additional to other retirement plans.
Limitations
● Contribution limitations are dependent on compensation and age
Choosing the Best Option for your Business
Regardless of the size and structure of a business, there are several plans available to offer as part of your company's benefits package. Above, we highlighted four of the most common plans. However, more options exist, and information is easily accessible on the IRS website.
When deciding on retirement benefits for your business, you must have a basic understanding of all the options available to you. You also want to consider the demographic of your employees and what retirement plan options make the most sense for them. Then, carefully choose a plan that best aligns with your business goals, needs, and values.