Small Business Retirement Plans
When selecting a retirement plan for yourself is an important decision that not only affects your future retirement savings but also your ability to attract and retain talent in the long term. There are many ways for small business owners to save for retirement. The purpose of this article is to explore three popular options, the Defined Benefit Plan, the SEP IRA and the 401K. The key to selecting the right plan is understanding which one is right for you, your employees, and your business.
Defined Benefit Plans
Defined benefit plans offer higher contribution levels for small businesses with few or no employees. The 412e(3) plan combines annuity contracts and life insurance to achieve this. They are especially beneficial to the older small business owners who is has gotten a late start on retirement saving and wants to ensure that he or she has and adequately funded pension.
For example, someone age 55 who’s had at least $200,000 in income in 2013 can contribute $244,657 into an annuity only plan as a first year contribution. If they combine life insurance into the plan they can contribute up to $322,032 as a maximum first year contribution.
However, you give up a great deal of flexibility for the higher contribution level. The 412e(3) plans are designed for businesses that can establish and maintain a specific contribution rate. These plans work because of the contractual nature of the plans including guaranteed contribution levels and guarantees from the insurance company sponsoring the plan. No loans are allowed from the plan. There is no flexibility for a down year, so a business that is highly cyclical in nature, this may not be the best option.
Anual Contribution Max
Simplified Employee Pension Plan is a popular plan option for business owners. One of its key features is its flexibility. Unlike defined benefit plans, SEP IRAs allow for flexible contributions. This may prove particularly important to a company where business is cyclical in nature.
Who can participate?
The rules for participation are not complicated. An eligible employee, including the business owner, is defined as someone 21 years old who has received at least $550 in compensation who has a minimum of 3 years of service.
Employees are nonresident alien employees who do not have U.S wages, salaries or personal service compensation from the employer is excluded. Also employees covered by a union agreement and whose retirement benefits where negotiated between the employee union and the employer.
SEP Contribution Limits
Contributions an employer can make to an employee's SEP-IRA cannot exceed the lesser of 25% of the employee's compensation, or $51,000. This is for tax years 2013 and 2014.
The 401K is possibly the most commonly recognizable option by both business owners and employees. There are additional benefits that pension plans do not offer but with those benefits come associated risks. It is typical for 401K plans to allow loans, where your risk is the funds that you’ve borrowed are not earning in the market. Another risk is market based; you can lose money in a market downturn. Conversely you can make money in up market as well. Additionally, there are multiple options within the 401K.
The simple 401K is the most common.
Elective Contribution Limits
The limit on employee elective deferrals (for traditional and safe harbor plans) is: $17,500 (in 2013 and 2014). If permitted by the 401(k) plan, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The additional elective deferrals you may contribute is: $5,500 to traditional and safe harbor 401(k) plans (in 2013 and 2014) and $2,500 to SIMPLE 401(k) plans (in 2013 and 2014)
Annual contributions to all of your 401K - this includes elective deferrals, employee contributions, employer matching and discretionary contributions and allocations of forfeitures to your accounts - may not exceed the lesser of 100% of your compensation or $51,000 for 2013 and $52,000 for 2014.
In addition, the amount of your compensation that can be taken into account when determining employer and employee contributions is limited. The compensation limitation is $255,000 for 2013 and $260,000 for 2014.
A Plan that is designed specifically for Self Employed individuals with no employees. This plan is also an option
Every year 401K plans are required to undergo testing to ensure that business owners and highly compensated employees do not disproportionately benefit from the plan compared to the other employees. In 2014, anyone making $115,000 or who is a 5% owner is considered a highly compensated employee.
Safe Harbor 401K
The Safe Harbor 401K is the answer to non-discrimination testing. Like a traditional 401K however it’s designed for companies that are at risk of failing annual non-discrimination testing. The Safe Harbor 401K allows Highly Compensated Employees to take full advantage of maximum salary contribution deferrals even when employees make little or no contributions at all.
How does it work?
Safe Harbor 401K’s must make contributions to the business owner, highly compensated employees and non-highly compensated employees in a matter that is deemed fair or non-discriminatory and there are three methods to accomplish this: the basic method, the enhanced method, and the non-elective method.
The trick will be figuring out which is best for you and your business..
As always, you should consult with an independent advisor and your tax consultant when deciding which plan is best for you and your business. This is not intended to be tax or legal advice from. Dennis Morrison-Wesley or Reliable Retirement Resources, LLC. Please consult your tax advisor or attorney for advice in your specific situation.