As a small business owner, you’ve worked hard to plan out your retirement strategy, and now you’re ready to put a formal retirement plan in place for you and your employees. Not only does a retirement plan offer a great benefit for employees, but it also offers tax savings for you.
So, what retirement plan is best for you and your business? That depends on several factors. Read more to learn what could work best for you!
How do small businesses with employees offer retirement plans?
One big factor in what retirement plan you choose is whether or not you have employees. If you don’t have any employees, you have to consider the administrative costs of the plan and your ability to make contributions, but you don’t have to consider how to compensate your employees.
Learn more about the best retirement plans for businesses without employees here.
If you do have employees, there are special rules called “eligibility rules” that you need to keep in mind.
Eligibility rules are rules about how much you can contribute to yourself and your employees. They tie the amount you can contribute to yourself to the contributions you make on your employees behalf, as well as to the contributions your employees make for themselves.
This means that as you plan how much you will save in any given year, you must also consider how the additional required contributions impact your budget and your employee compensation.
While you might like to heavily weight employee compensation towards retirement contributions so you can contribute more yourself, employees might be unhappy to have their compensation tied up in retirement accounts.
What is the best small business retirement plan?
There are many types of small business retirement plans. These can be broken down into three broad categories: IRAs, Defined Contribution Plans, and Defined Benefit Plans.
Individual retirement accounts (IRAs)
With these, the employer sets up an IRA for each individual employee.
Within this category, you can:
- Set up a payroll contribution to employees’ individual traditional or Roth IRA.
This limits the ability for the employee (and yourself) to save, as they won’t be able to save in an IRA and in a separate employer plan.
- Set up a Simplified Employee Pension (SEP) IRA.
This can work if you have a small team, but the contributions can grow to be quite large as you have to pay yourself and your employees the same percentage of compensation.
- Set up a SIMPLE IRA (Savings Incentive Match PLan for Employees).
While this is inexpensive to set up, it has a smaller contribution amount of $14,000 in 2022. 401(k) plans, described below, offer $20,500 of contribution room, as long as the plan contributions meet ERISA guidelines. You also do have to provide a 3% match to employees.
Defined Contribution Plans
You’ve probably heard of a 401(k) before. A 401(k) is a type of defined contribution plan.
With these plans, employers and employees contribute to the account, and the amount you receive in the end is based on how the account grows.
For defined contributions, there is an employee maximum contribution of $20,500 in 2022 and catch up contribution of $6,500 for those 50 or older. The employer may also be able to contribute another $40,500 for a total of $61,000. This depends on the details of your plan.
Defined contribution plans can be a great option for small businesses with employees. You can customize exactly what kind of plan you have to best suit your business.
For example, if you have seasonal employees, you can require that the employee work for some period of time before being eligible for a retirement plan. This prevents the administrative burden of dealing with a large number of small retirement accounts, meaning you save on administrative time and your employees’ contributions aren’t eaten up by any fees associated with the account.
Types of defined contribution plans include:
- Profit Sharing Plans
With Profit Sharing Plans, you can make large contributions to retirement accounts for yourself and your employees. Contributions are optional, which means you can provide a contribution in good years, and skip contributions in lean years.
- Safe Harbor 401(k)
With a Safe harbor 401(k), you are required to contribute 3% to eligible employee accounts. However, this gives you as the owner the ability to max out your account without worrying about eligibility testing. I.e. – if your employees don’t contribute enough on their own, the business owner is not limited in what he or she can contribute.
- Traditional 401(k)
With a Traditional 401(k), you and your employees can contribute based on plan rules, and you do have to be mindful of the ERISA rules regarding eligibility. You can also offer Roth and after-tax contributions for additional ways for you and your employees to save.
Defined Benefit Plans
These are what you typically think of as a pension.
With Defined Benefit Plans, the benefit you receive is calculated according to plan rules rather than contribution and account growth alone.
If you want to reward a bunch of highly compensated employees in an equal manner, this can be a great account. However, contributions are mandatory once the plan is established, so you’ll want to make sure you have good cash flow.
Is it best to establish your own retirement plan or join a group?
Establishing your own retirement plan can be a great option. You can customize your ability to save in the way you want while putting away lots towards retirement.
However, you can also join a Professional Employer Organization or some other group plan. This is a way to offer the ability to save for retirement without having to run the plan yourself.
As a small business, creating a retirement plan is a great way to save for retirement while also providing a benefit to your employees. To determine what plan is best for you, work with a professional who can design a retirement offering that is right for you and your business.
If you’d like to reach out and talk through your needs, I offer free 1:1 consultation to see if we’d be a good fit to work together! https://aligningwealth.com/contact