Choosing a Retirement Plan for Your Business

Blog
February 26, 2018

Retirement is a goal of almost everyone and people frequently find themselves asking, “How can I save more money for retirement?” Statistics say 1 in 3 Americans have zero retirement savings. This is particularly concerning when experts say retirement can last far longer than most people expect and you need more money to live comfortably than you think. By starting a retirement plan, both employers and employees save for the future. Retirement savings offer many tax advantages in that assets grow tax-free, contributions may be tax-deductible, and special tax credits may also be available. The good news is that starting a retirement plan and saving is easier than you think!

There are many different types of retirement plans to choose from and factors to consider. They include how much the employer wants to save, the number of employees they have, and how much administrative burden each plan requires. Below is a summary of the variety of plans there are to choose from:

Simplified Employee Pension (SEP)

A SEP is great for anyone that is self-employed.  Employers contribute a uniform percentage of pay for each employee, although they don’t have to make contributions each year. This flexibility is ideal for businesses whose profit fluctuates from year to year. For 2018, contributions are generally limited to the lesser of 25% of compensation or $55,000. SEP plans are particularly popular because they are easy to establish as they can be opened quickly through most brokers, with very little paperwork required. SEP plans also have low operating costs.

SIMPLE IRA Plan

SIMPLE IRA plans are an option for businesses with 100 or less employees. Employees can elect to make pre-tax contributions up to $12,500 in 2018. For those over the age of 50, that amount is increased to $15,500. Businesses must either match their employee’s contributions up to 3% of their compensation or make a fixed contribution of 2% for each eligible employee. Please note that the 3% match can be reduced to 1% in any two of five years. SIMPLE IRA plans are also particularly popular because they are also easy to establish and have low operating costs.

Profit Sharing Plan

Generally, this is a plan where only the employer decides whether to contribute. Employees do not make contributions and employer contributions are discretionary, meaning they can choose whether they want to contribute on a year by year basis and how much. One caveat of this plan is that contributions must be nondiscriminatory and “substantial and recurring.” The plan must contain a formula for how contributions are allocated to participants. For 2018, contributions are generally limited to the lesser of $55,000 or 100% of the employee’s compensation.

401(k) Plan

Employees can make pre-tax and/or Roth contributions. In 2018, contributions can be made up to $18,500 or $24,500 for those 50 or older. Employer contributions can be made – either as matching contributions or discretionary profit sharing contributions up to 25% of all eligible employees’ compensation. Combined employer and employee contributions cannot exceed certain amounts. In 2018, they have been capped at $55,000, or $61,000 for employees 50 or older, or 100% of the employee’s compensation.

Defined Benefit Plan

With a defined benefit plan, employers essentially guarantee a certain level of benefits at retirement. For example, they can set up a plan to pay out a certain amount each month at retirement. This type of plan requires actuarial services to determine the amount of contributions each year. Contributions vary annually and calculations may include several factors such as age, years of service, and compensation.  Generally, these types of plans are complex and costly, but can offer the highest level of savings available. For 2018, a defined benefit plan can provide an annual benefit up to the lesser of $220,000 or 100% of an amount equal to three consecutive years of the highest average compensation.

Each type of plan has caveats on which employees need to be covered, dates during the year that plans need to be established, and dates that contributions need to be made into the plans. Choosing a retirement plan depends on individual facts and circumstances, including the type of business, number of employees, cash flow, and goals.

Aronson can help you discuss your unique situation and determine what type of retirement plan fits your needs. If you have any questions, please contact one of our tax advisors at 301.231.6200.