No company is too small for a qualified plan
by Fred AdamsMost small business owners have to wear several hats to successfully run their company – CEO, administrative officer and marketing guru, among others. It’s no wonder that researching and selecting the best retirement plan for your business is so daunting.
That’s why so many business owners and managers put off the decision and end up losing ground helping themselves and their employees save enough for retirement. A recent survey by the Employee Benefit Research Institute and Matthew Greenwald & Associates reports that nearly half of all workers have less than $25,000 saved for retirement.
It doesn’t have to be that way.
There is an array of plans for a small business employer. Three basic designs are defined benefit, target benefit and defined contribution.
Defined contributions make up the vast majority of small business plans. I will focus on these, given that more than 90 percent of all businesses on Cape Cod employ 20 or less workers.
Simple Employee Plan
The most simple and least costly plan to install and administer is the Simple Employee Plan. This is especially adaptable for self-employed individuals or small family-run companies. A SEP is easy to set up, has no costly outside administration requirements and needs minimum documentation.
It does, however, require a uniform percentage of contribution. If an owner wishes to contribute 20 percent, then each employee earning at least $500 (for 2007) must receive the same percentage of their income.
Employees with less than three years of service can be excluded. No employee contributions are allowed; the entire deposit is employer money. Employees are 100 percent vested immediately, which means the employees have full ownership of employer contributions. Plans allow a 25 percent (20 percent of net taxable income for a self-employed) contribution up to $45,000 for 2007.
Simple IRA and 401(k) plans
These are designed to promote employee participation and require a reasonable minimum contribution by the employer. Plan participants can contribute up to $10,500 per year on a pre-tax basis. Participants over age 50 can add a catch-up contribution of an additional $2,500.
The employer contributes a match equal to 100 percent of the first 3 percent of an employee’s contribution. An alternative is to simply contribute 2 percent to everyone, whether they participate in the plan or not.
Eligible employees earn $5,000 or more annually and will have completed the employer’s service requirement. All employer contributions are immediately 100 percent vested for the employee.
A key advantage to these plans is minimum reporting or documentation, so they can be installed and administered without additional fees. Since SIMPLE Employment Plans limit the maximum employee contribution to $10,500 plus the 3 percent company match, they are not as attractive to business owners who hope to maximize their total contributions. Also, there is no provision under a SEP to add discretionary profit sharing.
401(k) plans
401(k) plans can be designed for one person or more to obtain a higher contribution than available under other arrangements. There are three specific sources of contributions in a 401(k) plan.
The first, of course, is the employee contribution that is generally made with pre-tax dollars. (There has been a recent law change that now makes Roth 401 contributions available, but few plans have adopted these provisions.)
The second contribution source is the employer match, which can range from 100 percent up to 3 percent of an employee’s contribution, or 50 percent on the first 6 percent to 10 percent of an employee’s income.
A match is not mandatory, and any required employer contribution can be made from a discretionary year-end profit sharing contribution, which is the third source of plan contributions.
Under a 401(k) plan, you also can make the match or the profit sharing contribution subject to a deferred vesting schedule, which simply means that if an employee leaves after a short term of service, the employer can recapture that non-vested portion.
The vesting period can be as long as six years before 100 percent is granted – as long as a graded vesting schedule is used starting with 20 percent after two years of service.
There are several key factors that determine final 401(k) design. Plans must satisfy certain testing requirements to make certain the plan does not discriminate in favor of highly-compensated employees – those earning more than $100,000 for 2007. Contributions made by these employees are limited by the amount contributed by non-highly compensated employees. A Safe Harbor provision plus a minimum 3 percent contribution can be a solution here also.
Advantages under a 401(k) plan include pre-tax contribution limits of $15,500 (2007) per employee. If someone is age 50 or older, an additional $5,000 can be made – bringing the total to $20,500.
In addition, the overall limit of $45,000 per person can be obtainable for key people by efficiently utilizing a combination of the three resources: employee contributions, employer match and employer profit sharing. Often this goal can be achieved and still have a minimum overall contribution from the employer of 3 percent to 4 percent.
401(k) plans do require legal documentation. There are also annual reporting requirements to the IRS and the U.S. Labor Department. These services are available directly from the plan provider or an independent third party administrator.
Installation costs, including the plan documents, can vary from $500 to $1,000, depending upon the circumstances. Annual administrative fees that include the reporting requirements run from $500 to $1,500. If an outside trustee is used – an option that usually can be avoided – an additional $500 to $750 per year is normally required. These expenses are deductible.
In addition, an employer with fewer than 100 employees can obtain a tax credit equal to 50 percent of plan startup and annual administrative costs up to $500 for each of the first three years for a new plan where one currently does not exist.
It’s generally recognized that without American employers providing employees with retirement plans, the American retirement system would be in tremendous disarray.
However, I find that most employers want to be sure their employees appreciate the plan. The best way to assure that is to hold employee meetings and communicate regularly about your plan’s benefits.
Fred Adams is an Investment Advisor Representative for Winslow, Evans & Crocker and is an Independent Third Party Administrator with offices in South Dennis. He can be reached at fadams@e-winslow.com.
Published in Cape Business Health & Wealth July/August 2007
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