Many small business owners want to find new ways to attract and retain talent. Offering an employer-sponsored retirement plan is one way to do that but many small businesses don’t know where to begin.
Recent surveys have shown that along with competitive pay, employees want paid time off, medical benefits and access to a retirement plan. They want all four things equally. So what should a small business owner do if they want to offer a retirement plan?
They must first decide what type of plan they want to offer. There are three options available to small businesses: 401(k)/403(b), Simple IRA and SEP IRA. Defined contribution plans are by far the most popular option, but many companies are too small to have the human resources available to administer a DC plan. That’s when the Simple IRAs and SEP IRAs come into play.
William Doherty, vice president, Investment, for ADP Retirement Services, says that employees who are engaged at work perform better and that translates into better revenue growth for the company. Retirement plans are one way to get employees engaged and want to stay with a company for longer than a year or two.
Offering a plan can be good for the employer as well because it offers business owners a tax deduction. There are also tax incentives available for small business to launch a new plan, up to $500 a year for three years, he says.
Defined contribution plans are a great option and don’t have to be complicated to run, says Doherty. “Many recordkeepers out there make it a pretty simplistic process,” he says. They make it very easy for small businesses to offer a plan by doing much of the heavy lifting for them, including helping plan sponsors with tax form filings, employee communication and a pre-packaged investment menu.
Sole proprietors, partnerships, limited liability corporations and tax-exempt employers can all offer a 401(k) plan. To begin, an employer must decide what to put in the plan document. The document must set out who can participate in the plan, how long they have to work for the company before they can participate or become vested in the plan and whether there is an employer matching contribution. If there is a match, the plan document must set out the formula for the match. The employer must also determine if it will allow employees to take loans from their retirement accounts.
“Most providers have a pre-approved plan document; a prototype plan document where employers can check a box and it is not really that daunting of an exercise,” Doherty says. The employer also must decide who the trustee will be for the plan assets. Most providers are aligned with a trustee they trust but many times plan sponsors will choose their own or self-trustee the plan, which is more risky.
A 401(k) allows an employer to participate in the plan if they want. They can offer a match or a non-elective deferral or they don’t have to provide a match at all. If they do decide to provide a match, they can attach the vesting schedule to their plan document. Many plans require employees to work for the company for at least a year before they are eligible to participate in the retirement plan and others require a certain number of years’ commitment to become fully vested in the employer contributions to their retirement account.
If an employer decides to offer a 401(k) or other DC plan, they must make sure they pass nondiscrimination tests on the plan, which means that a company’s highly compensated employees can’t receive more robust benefits from the plan than those employees who aren’t highly compensated. If a plan fails nondiscrimination testing, corrective action will have to take place, he says.
Employees can put their money in the plan pre-tax or after tax if it is a Roth 401(k) option. The maximum contribution limit for 2016 for a 401(k) plan is $18,000 with up to $6,000 in catch-up contributions allowed for people over age 50. Many 401(k) plans include about 25 investment options, including a target-date fund and a managed account option to give employees choices.
Many companies are including automatic enrollment and automatic deferral increases to their plan to get as many employees participating in the retirement program as possible. They also offer advice and guidance solutions for employees who aren’t as confident at managing their retirement account investments.
Simple IRAs are generally easier to administer than 401(k) plans.
“It covers most of your employees and plan participants can still make plan deferrals. Employer contributions are mandatory and vest immediately,” says Doherty. “A 401(k) does not mandate that an employer must contribute.”
Contributions can either be a dollar-for-dollar matching contribution up to 3% of an employee’s annual compensation or a non-elective contribution of 2% of the employee’s compensation up to an annual limit of $265,000. If an employer decides to make non-elective contributions it must make them for all eligible employees whether or not they make salary reduction contributions, according to the IRS.
The Simple IRA satisfies nondiscrimination testing because it has to cover most employees and contributions are mandatory.
“These are a cost-effective way to launch a retirement benefit for employees,” Doherty said. “Contributions and earnings grow tax deferred until withdrawal.”
An added benefit of the Simple IRA is that employers don’t have to file a Form 5500 with the IRS and there is no limit to what employees can invest their retirement dollars in, unlike a 401(k) which is limited to a preselected menu of investment choices.
Employees can contribute up to $12,500 per year, which is less than a 401(k) and employees over age 50 can make catch-up contributions of $3,000 per year.
SEP IRAs can be established by the employer or a self-employed individual. They are 100 % funded by employer contributions, which are fully vested immediately. Employer contributions must be the same percentage of compensation across all eligible employees. Employees must be 21 years old to participate in the plan and be employed at least three of the last five years earning a minimum of $600 in compensation.
Whichever plan you choose, Doherty says it is crucial that companies promote their plan to employees.
“We see this a lot where the sponsor goes to the trouble [to launch a plan], has great intentions but doesn’t promote the plan. It is really important for the plan and plan sponsor to promote the plan. There are a lot of great benefits here,” he says.
Not only are employees who participate in a retirement plan more engaged, but just having a plan can increase loyalty.
“We know employees in the U.S. are not saving enough for retirement. The average household has no retirement savings,” says Doherty. “They can’t rely on Social Security and will be ill-prepared when it is time to retire.”
He adds that if “we can get plan participants in the program, engaged, on track and have a plan, it leads to more engaged and productive employees.”
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