Retirement plans that are typically offered by employers include: 401(k)s, profit-sharing plans, money-purchase pension plans, defined benefit pension plans, tax-sheltered annuities or 403(b)s, simplified employee pension plans or SEPs, savings incentive match plans for employees or SIMPLEs.
Before choosing a retirement plan, it's a good idea to meet with an actuary, pension attorney or pension consultant to discuss the various options available. Choosing the right plan and performing the ongoing administrative and testing is complex and should not be handled by amateurs. Listed below are the types of profit-sharing plans available that make the most sense for small-business owners.
The 401(k) plans give participants the power to defer part of their pay on a deductible basis. This plan can be used in conjunction with a qualified profit-sharing plan or as part of an employee stock-ownership plan, or ESOP. Participants can defer up to $10,000 of their pay as long as the deferred amount is no more than 25 percent of their total compensation. The investments that can be used with these plans are numerous, from stocks, bonds, government securities, and mutual funds, to annuity contracts, insurance contracts, and bank-commingled trust funds.
For-profit businesses, such as corporations, sole proprietorships, partnerships, limited liability partnerships, and not-for-profit organizations such as hospitals, trade associations, schools, and charities can offer 401(k)s.
The advantage of a 401(k) for an employer is the minimal costs that would be incurred. Usually the fees for an employer with fewer than 250 employees is $1,000 to $2,000, plus an annual per-participant fee of $25 to $50. The disadvantage for the employer is that some employees might choose not to participate. Sometimes, this may limit the higher-compensated employee's ability to invest larger amounts in the 401(k) plan.
Qualified profit-sharing plans
This is a type of defined-contribution retirement plan. Contributions are made by the employer and may be from current or accumulated earnings and profits. The contribution, which is flexible, ranges between 0 percent to 15 percent of each employee's salary. To determine how much is to be given, the employer must create a formula and explain it in the plan documents. This formula can be geared to favor certain age groups, employment tenures, pay levels, or divisions-as long as it passes nondiscrimination tests. Also, certain groups covered by collective bargaining agreements can be excluded.
Any company that offers a 401(k) plan can offer a profit-sharing plan feature as well. Also, profit-sharing plan assets can be invested in the same type of assets as 401(k) plans. The benefit of profit-sharing plans to the employer is that it enables them to make contributions, but they aren't locked into a fixed annual commitment regardless of bottom-line performance.
Simplified employee pension plans
SEP plans were created for small-business employers to encourage them to set up retirement plans for their employees. Under this plan, contributions of up to 15 percent of each employee's compensation is made to an IRA account established and managed by the employee. SEP plans make the whole process easy and less costly on the administrative end for employers. They simply make a contribution to an IRA account. The amount, however, must be the same percentage for all employees regardless of tenure or position. This may mean that contribution costs could be higher than what the employer would like to contribute.
Employees eligible for SEP plans can be required to be at least 21 years old and have worked for the company during any three of the last five years, and earned at least $400 in pay for the plan year in question. Anyone who meets these requirements must be covered, except those who are covered by collective-bargaining agreements. Companies sponsoring SEP plans can use all funding vehicles available with IRA accounts and must follow all restrictions.
Under a Savings Incentive Match Plan for Employees, employees can defer part of their pay into an IRA account, and the employer will match it. In many ways, this is similar to a 401(k) plan. Salary deferrals are limited to $6,000 per year. Also, employees eligible for SIMPLE plans must have earned at least $5,000 in a two-year period and are expected to earn at least $5,000 during the present year. Employers provide a 100 percent match on deferrals of up to 3 percent of compensation. This match limit can be reduced if notice is given 60 days before the deferral election period. Thirty days before year's end, each participant must receive a statement showing the amount in the account and the account's activity.
Companies with fewer than 100 employees and which are not offering other qualified plans can offer SIMPLE plans. The employer benefit is that SIMPLE plans are easier to administer than 401(k) plans. However, due to decreased flexibility and the fact that the required match-contribution costs may be more expensive than 401(k)s, they may be less attractive.
Louis P. Stanasolovich is founder and president of Legend Financial Advisors Inc., a North Hills-based Securities and Exchange Commission-registered investment advisory firm that provides asset management and comprehensive financial-planning services on a fee-only basis to individuals and businesses. Legend Financial Advisors, Inc.'s Web site is at www.legend-financial.com.