A Good Retirement Plan Is Good For Business
Edition: September 2001 - Vol 9 Number 09
Author: Richard Yercheck
America has become a nation of entrepreneurs. It's true that the very nature of employment has changed with the advent of start-ups, telecommuting, and contract employment. If you are a sole proprietor, contract employee, or one of millions of the ''new virtual workforce,'' you may be constantly juggling time, staff, and resources. One of the last things you have time to think about is a retirement plan. Yet, it is one of the first items of business you should consider. Why? There are several reasons:
You and your employees benefit from having money invested tax-deferred for retirement.
The right retirement plan helps attract and retain good employees, and some plans, such as profit sharing plans, may also promote productivity.
Contributions made by an employer can generally be deducted as a business expense.
Be aware that not all plans are alike. There are standard, one-size-fits-all prototype plans that are designed to meet Internal Revenue Service requirements. You may instead want to consider a customized plan, designed specifically for your situation. This decision usually depends on the size and complexity of your company and your company's needs and those of your employees.
To help you get started, here are some basic choices in retirement plans:
Simplified Employee Pension (SEP)
Under a SEP, a company sets up a tax-deferred IRA account in each employee's name. For 2001, the company can contribute to the account an amount equal to as much as 15 percent of the first $170,000 of each employee's salary, up to $25,500.
A company must cover everyone who is at least 21 years of age and has worked for the company in three out of the last five years (including part-time workers). This is a disadvantage for firms that employ people who work only occasionally. In addition, SEPs don't allow vesting schedules, which require an employee to stay with you a certain number of years before they can take full possession of the account.
However, SEPs do have several advantages: They are simple to establish, incur no administration expense or trustee liability, and allow maximum contribution flexibility. A SEP is often a good choice for a sole proprietorship or a small company.
Savings Incentive Match Plan for Employees (SIMPLE)
The Small Business Job Protection Act of 1996 created the SIMPLE, which became available January 1, 1997. In general, the SIMPLE plan consists of a deferral program for eligible employees and a contribution made by employers. The SIMPLE plan is easy to administer and far less costly to set up and maintain than a typical qualified retirement plan such as a 401(k) Plan.
SIMPLEs are available to employers who did not have more than 100 employees who earned $5,000 or more during the preceding calendar year. Employees may defer a maximum of $6,500 in 2001 from salary (pre-tax) and maximum employer contributions may be up to 3% of compensation. The employer has limited fiduciary responsibility and no trust liability for the investment decisions of the participants. With low set-up and annual maintenance costs, minimal paperwork, no IRS 5500 or Department of Labor filings, no required discrimination testing, and no top-heavy testing required, the SIMPLE plan is truly a retirement plan that lives up to its name!
Profit Sharing Plans
A profit sharing plan resembles a SEP because the company, not the employees, contribute the money, which normally can be as much as 15 percent of salary in 2001. Unlike a SEP, however, a profit sharing plan gives the employer greater flexibility and control and can require a vesting schedule.
There are different allocation (or contribution) methods available for a profit sharing plan such as the age-weighted or new comparability methods that may allow certain employees to receive as much as 25 percent of salary up to $30,000 a year. These allocation options target employees who meet a specific criterion, such as employees who are over a certain age or income level or who have additional years of service. These special allocation methods are not available in pre-approved prototype form and require special attention.
Money Purchase Pension Plan
The Money Purchase Pension plan allows for as much as 25 percent of salary up to $30,000 for all eligible employees. Next year, this same 25 percent of the compensation limit will apply to Profit Sharing Plans. The main difference between a Profit Sharing Plan and the Money Purchase Pension Plan is that a contribution to this type of plan would be an annual commitment.
The 401(k) plan is a profit sharing plan with the addition of a salary deferral feature. The employees seem to have more incentive to contribute to their own retirement through a 401(k) because employers often contribute a matching amount. With a 401(k) plan, employees who participate put in their own pre-tax money up to the current $10,500 limit (indexed for 2001). The employer can also contribute, but the annual total for each person in 2001 cannot exceed 25 percent of salary up to $30,000. Employers can also be offered a loan option in a 401(k) plan. A 401(k) requires nondiscrimination testing and various tax returns and reports. Because of the amount of testing and regulations, the services of a professional plan administrator are strongly recommended.
In addition to these basic choices, there are a number of other specialized types of retirement plans that can be facilitated by professional assistance. The Economic Growth and Tax Relief Reconciliation Act of 2001 also contains dozens of provisions that affect employer-sponsored retirement plans. So, it may be wise to hire a professional to advise on choosing the type of plan that will work best for you and your employees.