Your business may be small, but that doesn’t mean you can’t offer the attractive retirement packages that the big guys offer.
Even if a small business isn’t able to offer the same high salaries as its big business competitors, a small business can stay competitive by offering an attractive retirement package, says Chris Kunze, chief operating officer at Perspectives Ltd. An attractive retirement package can help you stay in the running for the best talent, he says.
Retirement plans can be divided into two categories: defined benefit plan and defined contribution plan. A defined benefit plan is fully funded by the employer. By participating in a defined contribution plan, participants are guaranteed a specific monthly benefit at retirement. This amount is usually determined by salary and tenure. A defined contribution plan allows you and your employees to deposit money into individual accounts. Employee and employer contributions vary by plan. At retirement, participants are able to withdraw the balance in the account. In most cases, experts recommend that small businesses stick with a defined contribution plan. Here are the different types of retirement plans:
The most popular employer-sponsored retirement plan used today, a 401(k) can be set up by businesses of all sizes. Between 2009 and 2010, 75 percent of businesses offered an employee-funded 401(k) plan, according to the 11th Annual Transamerica Retirement Survey. With a 401(k) plan, your employees agree to have a portion of their pre-tax income deposited into a retirement savings account each pay period. In 2010, the annual maximum that an employee can contribute is $16,500 and additional $5,500 for participants over 50, under the catch-up provisions. This amount can change annually. Most 401(k) plans don’t require employer contributions, but it does give you the option of matching the employee’s contributions up to a certain percentage, if you so choose.
In most cases, employees are responsible for managing their own accounts, including the investment amount and the plan options. Minus any fees and taxes, the employee will receive the balance on the account upon retirement. The method of payment will depend on the plan. Some plans will distribute it as a lump sum, whereas others offer a monthly dispersal.
- Profit Sharing
With such a large amount of economic volatility, many small businesses are hesitant to offer a profit sharing plan. But what many business owners fail to realize is contributions to a profit sharing plan are discretionary. Contributions are decided by a predetermined formula, but there is no minimum contribution. If you had a bad year, you don’t have to make a contribution.
Businesses of all sizes can host a profit sharing plan. It’s entirely employer-funded. In 2010, contributions must not be greater than 25 percent of compensation or $49,000. The administrative costs may be higher in these plans, according to the IRS’s Plans Navigator. Also, businesses must perform annual testing to ensure that the plan doesn’t favor highly compensated employees.
Many of these plans allow employees to take out a loan or hardship withdrawal against the plan.
- Simplified Employee Pension (SEP)
An SEP is typically not as flexible as a 401(k) or profit sharing plan. Like a profit sharing plan, however, you can decide whether and how much to contribute to the plan each year. Contributions to an SEP can only be made by the employer, up to 25 percent of an employee’s compensation or $49,000.
If you set up an SEP, you must cover all employees who are at least 21 years of age and have been working for you three of the last five years with compensation of at least $550. With an SEP, Employees are not allowed to take out loans against their plan, but they can withdraw their balance at anytime. If they withdraw early, they will be subject to any fees or taxes owed to the account.
SEPs are easy to set up and manage. And when retirement time rolls around, participants can collect the balance of the account.
- Savings Incentive Match Plan for Employees (SIMPLE) IRA
A more strongly regulated plan, a SIMPLE IRA can only be established by businesses with less than 100 employees that have no other retirement plan options. Both employees and employers can contribute to a SIMPLE IRA plan. Employees contribute by agreeing to allocate a fixed percentage of each paycheck to their plan every pay period. This amount is taken from their paycheck before taxes and deposited into their individual retirement account. Employees are allowed to contribute up to $11,500 annually.
Participants who are older than 50 years old are allowed to contribute an additional $2,500.
Unlike the previously mentioned plans, this type of plan requires employer contributions. With a SIMPLE IRA, employers must make either matching contributions of up to three percent or a two percent contribution to all participants, according to the IRS’s Retirement Plans Navigator. By law, you must enroll all employees who make at least $5,000 in any two prior years and are expected to earn $5,000 in the current year.
At retirement, the participant’s payout is based in the account balance. With a SIMPLE IRA, employees may withdraw their balance at any time, minus taxes. Withdrawals made in the first two years may also be subject to an additional early distribution tax of 25 percent. These plans are said to be easy to start and manage, but with all the stipulations, there is little room for flexibility.
- Defined Benefit Plan
Because of its many administrative requirements, a defined benefit plan isn’t a common choice for small businesses. Contributions to your defined benefit program are based on a formula that your company creates at the start of the plan. Some plans will require enrolled employees to contribute, while other plans do not.
Employers are obligated to make the defined contributions annually, regardless of their financial situation. Once they’ve been set for the year, contributions cannot be reduced. If you don’t meet the minimum contribution, you will be subject to an excise tax. At retirement, employees can receive no more than $195,000 or 100 percent of their average pay per year.
Defined benefit plans are the most expensive type of plan a business can offer. But these plans offer many added benefits such as increased flexibility and early retirement options.