Selecting
the Right Retirement Plan for Your Business
Investing in retirement plans
offers small business owners a great opportunity to save taxes and build
retirement wealth. That’s because contributions to a qualified retirement plan
are deductible from current income, and the income generated by investments in a
retirement plan accumulate tax-free until withdrawn. Despite these benefits,
small businesses can still face challenges in determining which is the best plan
for them. The following overview should be helpful to help business owners
better understand their options.
SIMPLE IRAs
To encourage small business
owners to provide retirement benefits for their workers, The Small Business Job
Protection Act of 1996 created the SIMPLE (Savings Incentive Match Plan for
Employees) IRA, a retirement plan without the complex nondiscrimination rules
and reporting requirements of other retirement plans. SIMPLE IRAs are generally
available to businesses with 100 or fewer employees. Eligible employees are
those that can reasonably be expected to earn at least $5,000 for the current
year and who received at least $5,000 in compensation during any two preceding
years.
SIMPLE IRAs are funded through
a combination of employer and employee contributions. For 1999, employees can
contribute up to $6,000 of net earnings. The business owner must either match
each employee’s contribution (up to 3 percent of the employee’s wages) or
make a flat contribution equal to 2 percent of each eligible employee’s pay
(regardless of whether or not the employee contributes to the plan). Once the
money is in the plan, the SIMPLE IRA works much like a traditional IRA.
401(k) Plans
401(k) plans are popular
retirement programs, but they are generally more complicated and expensive to
administer than other plans. A typical 401(k) plan allows employees to
contribute a pre-tax portion of their earnings. Participants can decide each
year whether and how much they want to contribute (within tax code limits). For
1999, the maximum that can be contributed to a 401(k) is the lesser of 25
percent of earnings or $10,000. Employers may offer matching contributions.
Employers who offer 401(k) plans must meet stringent nondiscrimination rules
requiring that a sufficient percentage of non-highly-compensated workers
participate in the plan.
SEP Plans
In a Simplified Employment
Pension (SEP) plan, the employer makes deductible contributions to IRAs set up
for employees. Employees do not contribute to a SEP, but employers who make
contributions for themselves must make contributions to all employees who meet
age and years-of-service tests. The maximum contribution is 15 percent of
compensation (up to $160,000), or $24,000, whichever is less. Contribution
levels are flexible and can be adjusted (within plan limits) each year as long
as there is no discrimination among the way employees’ plans are funded. There
are no annual reporting requirements as there are for Keoghs and some other
qualified retirement plans, making SEPs relatively easy to set up and
administer.
Keogh Plans
Under the “money purchase”
version of a Keogh plan, a sole proprietor, partner, or limited liability
company member can set aside as much as 25 percent of eligible income, or
$30,000, whichever is less, on a tax-deferred basis. Under the “profit
sharing” version of a Keogh, the limits are up to 15 percent of eligible
income, or $24,000, whichever is less on a tax-deferred basis.
When you establish a Keogh
plan for yourself, all eligible employees must be included in the plan on a
nondiscriminatory basis.
There are two types of Keogh
plans: A money purchase plan that requires a mandatory contribution level each
year regardless of whether the business shows a profit, and a profit-sharing
plan in which contribution levels may change each year. Because Keoghs allow
larger annual contributions, they are popular with high-earning business owners.
Making the Right Choice
In determining which
retirement plan is the best for you and your business, it is important that you
clearly identify your objectives and carefully consider a number of factors.
The
cost to cover employees — If you have few or no employees, you can base
your decision primarily on which plan will be most beneficial to you. On the
other hand, businesses with a large number of employees must consider the costs
involved in covering employees and determine the extent to which tax advantages
offset these costs.
The
level of complexity — You also need to consider the complexity of
the plan and the reporting requirements. SIMPLE IRAs and SEPs are easier to set
up and maintain than Keoghs and 401(k)s.
When
you expect to retire — The closer you are to retirement, the greater
the need to select the retirement plan option that will allow you to contribute
as much as possible.
Contribution
requirements — If your business has good and bad years, you
might want to steer clear of plans, such as the SIMPLE IRA and the Keogh Money
Purchase Plan, that require annual contributions.
Selecting the right retirement plan can have
far-reaching and long-lasting effects on your retirement and your business. A
professional can help select the best plan for your needs.