Retirement Plan Selection: How to Find the Best Option for Your Business

A man is looking at his computer as he works through the retirement plan selection process.

Retirement plan selection a task you can't afford to get wrong. Here's why.

Retirement savings plans are one of the most highly requested benefits among job seekers and job holders concerned about sustaining their future. Those offering a competitive retirement plan attract some of the 81 percent of job seekers who say retirement benefits are a significant factor in their job search and can avoid losing some of the 49 percent of jobholders who are willing to apply elsewhere because of their dissatisfaction with their benefits programs.

If you are interested in using your company’s funds to help your employees save up for their retirement years, read on.

 

What is a retirement savings plan?

A retirement savings plan is an account set up by an employer or employee to cover post-career living expenses. Funds that are invested can be accessed when participants reach a defined age—or sooner if a participant is willing to pay a penalty.

 

What are my employees looking for in a plan?

Several factors are important. These include:

Whether the employer will make or match contributions

How taxes will be treated

Whether money can be accessed early

Whether mandatory withdrawals are required

Whether employees can continue to contribute after reaching retirement age

How a plan can work into their estate plans

Whether a plan will accept rollovers

.

Pro tip: Your employees’ needs and preferences will determine the effectiveness of any plan you select. You might consider surveying your employees to find out which points matter most before making a selection.

 

What kinds of retirement plans can I offer?

There are eight retirement plans you might consider:

SIMPLE IRA

401(k)

A 401(k) plan allows you and your employee to contribute to the employee’s retirement. Employee contributions are treated as deferrals of income; taxes aren’t incurred until the employee takes a distribution.

 

Does my business qualify?

Businesses of any size can qualify, including those that already have other retirement plans in place.

 

What are the advantages?

The key advantage for employers is that this plan allows them to make contributions over a period of time rather than parting with a lump sum all at once.

There are many more benefits for employees:

  •  Employees may make larger contributions than they can with some other retirement plans (namely, IRAs).
  • They’re able to access the funds in their 401(k) accounts before retirement through participant loans or hardship withdrawals (which may be subject to an additional 10% tax if the employee is under the age of 59 ½.
  • The funds they contribute through salary deferrals are immediately fully vested.
  • At their discretion, employers may choose to contribute a preset amount or match employee contributions.

 

What are the drawbacks?

Administration can cause some headaches for employers: The costs of 401(k) administration are often higher than in other arrangements, and the options for loans and withdrawals can make administration a bit complex. Further, employers may need to prove that the benefits they offer don’t favor the highly compensated employees over those in lower pay grades, which can be challenging to test and verify.

For employees, the main drawback is that employer contributions may vest on a schedule. If employees resign or are terminated before the funds fully vest, they may miss out on a portion of that income.

 

What are the contribution limits?

In 2021, total contributions could not exceed $19,500 per employee for those age 49 or younger. Total contributions could not exceed $26,000 per employee for participants who are 50 or older.

 

Will I need to complete any additional filings?

You will need to file Form 5500 each year.

 

SIMPLE 401(k)

A SIMPLE 401(k) plan is like a 401(k) plan in that employees can choose to defer a portion of their compensation to use post-career. However, three attributes make this plan unique:

  1. You, the employer, must commit to making a matching contribution of up to 3% of each employee’s pay or a non-elective contribution of 2% of each eligible employee’s pay.
  2. No other contributions can be made to a SIMPLE 401(k).
  3. Employees are fully vested in all contributions.

 

Does my business qualify?

Businesses with 100 or fewer employees can establish SIMPLE 401(k) plans, provided they have no other retirement plans in place.

 

What are the advantages?

Administration of these plans is easier than conventional 401(k) plans. Benefit formulas simplify the administration process, and employers choosing this plan over a conventional 401(k) do not have to prove that their plans follow non-discrimination rules.

Employees benefit from SIMPLE 401(k) plans, too. As with conventional 401(k) plans, participants can access funds in their retirement savings through a participant loan or hardship withdrawal (which may include a 10% penalty for the participant). And, unlike conventional 401(k) plans, these plans allow employees to be fully vested through every contribution.

 

What are the drawbacks?

There are some drawbacks of this plan over other options. For employers, these include the same administrative burdens conventional 401(k) programs face in providing loan and withdrawal flexibility. Additionally, employers choosing this plan may not provide any other retirement plan options.

 

What are the contribution limits?

In 2020, employees under age 50 could contribute $13,500, and employees 50 or older could contribute up to $16,500. Employers could match their employees’ contributions dollar for dollar (up to 3% of their pay) or provide a 2% non-elective contribution for every eligible employee.

 

Will I need to complete any additional filings?

You will need to file Form 5500 each year.

 

Defined Benefit Plan

Defined benefit plans provide employees with a predetermined payout at the time of their retirement. Regular employer contributions, which are calculated by actuarial formulas, help them amass the savings they need to reach that target amount.

 

Does my business qualify?

Businesses of any size can qualify, provided they don’t have a retirement plan in place that prevents the adoption of additional plans.

 

What are the advantages?

The main advantage for employers is the ability to contribute and deduct a larger amount each year than they could through a defined contribution plan, such as a 401(k), profit-sharing plan, or money contribution plan.

Employees benefit greatly from this arrangement, which affords them a realistic picture of the funds that will be available to them upon retirement and assures them of a benefit that’s not dependent on business or investment performance. Further, this arrangement often permits participant loans, giving employees temporary access to their retirement funds.

 

What are the drawbacks?

There are drawbacks to this plan for employers. First, this plan can be costly and complex to administer because of the individualized calculations that must be completed to assure the correct benefit payout. Second, employers who under or over contribute to the plan may face an excise tax. Third, employers cannot retroactively decrease the benefit, even in times of hardship.

There are two drawbacks to this plan for employees: According to the terms that are set, plan funds may take years to vest fully, and fund withdrawals are generally not possible until the participant reaches age 59 ½.

 

What are the contribution limits?

The IRS states that there are limits to the benefits that an employer may provide, but they advise consulting with an enrolled actuary for details.

 

Will I need to complete any additional filings?

Employers must file Form 5500 each year. An enrolled actuary must sign Schedule B of the form.

 

Profit-sharing Plan

Through a profit-sharing plan, employers may make discretionary contributions toward their employees’ retirement savings. Businesses are not obligated to contribute a certain amount—or any amount at all—and they don’t need to be “profitable” to make this form of contribution. However, those who choose to contribute must use a formula (such as one that assigns each employee a percentage of the funds allocated to the plan that matches the percentage of wages or salaries they obtain from the firm’s total wages and salary) to determine a fair allocation.

 

Does my business qualify?

Any business can qualify, provided that it doesn’t have a retirement plan in place that prevents the firm from establishing other plans.

 

What are the advantages?

Many employers who choose this plan do so because of the flexibility it provides. Since employer contributions aren’t required, employers can preserve their cash on hand to cover shortages and downturns.

Employees benefit from this plan most in times of prosperity: Their shares of profits may help them receive more retirement-directed compensation than they might through other retirement arrangements. Additionally, employees may take loans against their profit-sharing plans, and they may withdraw the funds before retirement (though they’ll pay a 10% penalty for the withdraw if they are under the age of 59 ½).

 

What are the drawbacks?

Employers pay higher administrative costs than they might for other arrangements. Further, they are required to test that the benefits they offer don’t favor highly compensated employees over those in lower pay grades.

The drawback for employees is that they may not contribute to the profit-sharing plan. Employees who wish to contribute to their own retirement savings must establish a separate retirement account.

 

What are the contribution limits?

Employers may contribute up to 25% of an employee’s compensation, which cannot exceed $58,000 per employee, according to IRS guidelines for 2021.

 

Will I need to complete any additional filings?

Employers must file Form 5500 each year and submit participant disclosures.

 

Money Purchase Plan

Employers choosing a money purchase plan must make fixed contributions each year toward their employees’ retirement savings. Plan documents stipulate the contribution that’s required as a percentage of an employee’s pay. That percentage must be paid to every eligible employee, regardless of the profitability of the business.

 

Does my business qualify?

Businesses of any size can establish a money purchase plan, provided they don’t offer retirement plans that prevent them from establishing other retirement vehicles.

 

What are the advantages?

The key advantages for employers are the simplicity this plan provides and the ability to budget retirement obligations years in advance.

The advantages for employees are the opportunity to amass more savings than they might through other retirement arrangements, the ability to take out loans against the balance, and the ability to make their own contributions to the plan.

 

What are the drawbacks?

There are several drawbacks to consider. First, the administrative costs of these plans can be high. Second, employers must test that the benefits do not favor highly compensated employees over those in lower pay grades. Third, employers may be required to pay an excise tax if they don’t fulfill the contribution that’s stipulated in their plan.

For employees, the most notable drawback is that they cannot withdraw the funds while they are enrolled in the plan.

 

What are the contribution limits?

Employers may contribute up to 25% of an employee’s compensation, which cannot exceed $58,000 per employee, according to IRS guidelines for 2021.

 

Will I need to complete any additional filings?

Employers must file Form 5500 each year.

 

Simplified Employee Pension (SEP)

Through a SEP plan, employers can make contributions to an individual retirement account or individual retirement annuity created for each eligible employee.

 

Does my business qualify?

Any size business can qualify by adopting Form 5305-SEP, a SEP prototype, or a lawyer-drafted plan document. However, those who choose to qualify through Form 5305-SEP cannot offer other retirement plan programs to their employees.

 

What are the advantages?

SEP plans have many advantages for employers. They’re easy to establish and administer, and they don’t have the high startup or administrative costs that many other retirement plans require. Further, these plans allow for flexible contributions; employers can make large contributions (up to 25% of each employee’s pay) when cash flows are strong and reduce the amount when necessary.

Employees benefit from SEP plans, too. Through these plans, each employee receives an equal contribution (in terms of percent of pay rather than dollar amount), and they are immediately fully vested in the entire balance. Employees can also withdraw their funds before reaching retirement age, though the funds they withdraw will be counted as taxable income and may be subject to an additional 10% penalty if the participant is under age 59 ½.

 

What are the drawbacks?

There are some drawbacks to these plans. Employers may not offer SEP plans in conjunction with any other non-SEP retirement plan (if the plan is established through Form 5305-SEP). And, employers must be equitable in their payouts to employees (in terms of the rate paid rather than the dollar amount), so SEPs cannot be used to incentivize certain employees and not others.

One drawback for employees is that they may not contribute to their own SEP plan. If they wish to contribute to their own retirement savings, they must establish a separate retirement savings account. And, unlike with some other retirement savings vehicles, participants cannot borrow against their SEP plan or use those assets as collateral.

 

What are the contribution limits?

Employers may contribute up to 25% of each employee’s pay, but the total contribution cannot exceed $58,000 per year per employee (according to IRS SEP contribution limits set for 2021).

 

Will I need to complete any additional filings?

Employers usually have no filing requirements.

 

SIMPLE IRA

Employers may set up an agreement that allows eligible employees to contribute a portion of their salary to a SIMPLE IRA plan rather than receiving it as part of their regular pay. Both employers and employees can contribute to this plan.

 

Does my business qualify?

Businesses with 100 or fewer employees are eligible to form these plans through Form 5304-SIMPLE, Form 5305-SIMPLE, a SIMPLE IRA prototype, or a lawyer-drafted plan document. However, businesses may not offer any other retirement plan if they choose to offer a SIMPLE IRA.

 

What are the advantages?

Like a SEP plan, SIMPLE IRAs are easy to establish and administer, and they have minimal startup and administrative costs compared to many other retirement plans. Further, entities offering these plans do not have to meet discrimination testing requirements.

Employees are immediately fully vested in the full balance of their SIMPLE IRA, and unlike with a SEP plan, they may contribute to their own accounts. Employees may make withdrawals from their account, but the funds they withdraw will be counted as taxable income and may be subject to a penalty (10% for employees under the age of 59 ½ or 25% for employees under the age of 59 ½ if withdrawing within the first two years of participation).

 

What are the drawbacks?

Employers offering SIMPLE IRAs to their employees may not offer any other retirement vehicles, and they must abide by strict rules regarding contributions. Specifically, they must contribute each year in one of the following ways:

  •  They must match contributions up to 3% of an employee’s compensation, or
  • They must provide a 2% contribution for every eligible employee, even those who opt-out of making their own contributions.

Employees may see these contribution rules as a disadvantage because the maximum contribution is lower than in some other plans.

Additionally, participant loans are not permitted.

 

What are the contribution limits?

Employers may match up to 3% of an employee’s compensation or provide an unmatched contribution that equals 2% of an employee’s compensation. The latter option is capped at $290,000 for 2021.

Employees may also contribute to their SIMPLE IRA plans through a salary reduction agreement, where the reduced amount is contributed directly to the SIMPLE IRA.

 

Will I need to complete any additional filings?

Employers usually have no filing requirements.

 

Payroll Deduction IRA

Payroll Deductions IRAs are not administered by employers. Instead, employers allow their employees to contribute to outside IRA plans through payroll deductions.

 

Does my business qualify?

Almost every business can provide this option.

 

What are the advantages?

From the employer’s standpoint, this arrangement is the easiest to establish and administer. Employers have no role in creating retirement accounts and simply transmit the portion of pay an employee elects directly to the traditional or Roth IRA they indicate.

The benefit for employees is that they have greater control over how much of their salary or wages is invested in their retirement and full say in the financial institution and investment options they’ll use to build their retirement accounts. Employees can also withdraw their retirement funds before reaching retirement age if necessary, though the funds they withdraw may be subject to income tax and a 10% tax penalty if the participant is under the age of 59 ½.

 

What are the drawbacks?

Employers cannot contribute to these plans, and they can’t claim a deduction for doing so. Further, these plans rarely help employers build goodwill among employees because they aren’t supporting their employees’ retirement in any meaningful way.

Employees cannot take out a participant loan against these funds, and they cannot use the assets as collateral.

 

What are the contribution limits?

Employers cannot contribute to these plans.

Employees may contribute up to the current IRA limits. As of 2021, these limits are $6,000 for participants under age 50 and $7,000 for participants age 50 or older.

 

Will I need to complete any additional filings?

Employers have no filing requirements.

How can I get started?

Once you have an idea of the kinds of plans you might consider, you must decide whether to administer your plan in-house or outsource your plan’s administration. If you choose to outsource, you might consider the following administrators accustomed to working with small businesses:

  •  Guideline. Guideline helps small businesses establish 401(k)s and SEP IRA plans. Base fees start around $40/month and cost $8/month per participating employee.
  • ShareBuilder 401(k). Sharebuilder 401(k) offers a variety of 401(k) plans for small business owners and employees. Plans start around $25/month per employee.
  • Dedicated DB. Dedicated DB administers defined benefit and cash balance services for small business owners. Defined benefit plans start at $1950 per year for the business owner and $150/year per participant. There is also a one-time fee for plan design and preparation.

 

Finally, you may consider working with an attorney to file documents to establish your plan and write your plan’s terms and conditions. If you would like to connect with an attorney who can help you with retirement plan selection and implementation, click the Connect button below to get started:

 

What’s next?

To learn more about the benefits you might offer your employees, read our article, Small Business Benefits: Your Guide to Getting Started.

Then, log into your owner’s portal for articles and advice that can help you lead your team, navigate your financial concerns, and prepare your business for growth.

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