If you think your business can’t afford an employee retirement plan, you’re not alone. In fact, 71% of small- and medium-sized business owners in a 2017 Pew Trust study said retirement plans were too expensive and too difficult to manage.
The problem is that employee retirement plans play an important role in helping your company recruit and retain the top talent that will help your business grow. The 2018 Transamerica Retirement Survey revealed that 88% of workers view a 401(k) or similar retirement plan as an important benefit.
Before you rule out offering a retirement plan, it’s best to understand your options. You may find that they are less expensive and easier to administer than you think.
This employee retirement plan guide will:
- Review retirement plan types available to employers
- Discuss the requirements and focuses of retirement plans
- Give you the questions an employer should ask when considering retirement options
Types of employee retirement plans
IRA-based plans
Individual Retirement Accounts (IRAs) are the most basic type of employee retirement plan.
There are three types of IRAs an employer can help their employees set up and fund:
- Payroll deduction. An employer is responsible for arranging contributions from an employee’s pay to their IRA. All employees are eligible to participate, but there is no requirement for employee contribution. There are no annual filing requirements for employers in payroll deduction plans. There is a limit to how much an employee can contribute — a maximum of $5,500 per year (those 50 and older in 2018 can make an additional catch-up contribution of $1,000, for a total annual IRA contribution of $6,500). This plan can either be a
- Traditional IRA, where contributions may be tax deductible and the portion of the contribution that was tax deductible also does not get taxed until distributed, or
- Roth IRA, where contributions are not tax deductible, but the distributions, including Roth IRA earnings, are not included in income.
- Simplified Employee Pension (SEP). The SEP allows just an employer to make contributions into employees’ and their own SEP-IRA accounts. Those contributions are capped at 25% of each employee’s pay. Under this plan all employees of the business must receive equal contributions but the annual amount an employer must contribute is not fixed. This gives smaller businesses some flexibility. A SEP does not have the same operating or set up costs as a conventional retirement plan.
- SIMPLE IRA. This plan is available to small businesses with 100 or fewer employees. Both the employee and employer make contributions to a SIMPLE IRA. Employers are required to match 3% of the employee's contribution or contribute at least 2% of an employee's total compensation if the employee opts to not participate. SIMPLE IRAs also have yearly employee contribution caps.
Before you rule out offering a retirement plan, it’s best to understand your options. You may find that they are less expensive and easier to administer than you think.
Defined contribution plans
Defined contribution plans are employer-established plans that don’t promise a specific benefit at retirement. Instead, employees or their employer (or both) contribute to employees’ individual accounts under the plan.
At retirement, the employee receives the total contributions plus earnings (or minus losses) on the invested contributions. According to the 2018 Retirement Confidence Survey put out by the Employee Benefit Research Institute, 76% of workers with a defined contribution plan are confident in having enough funds to retire comfortably versus 46% who don’t have one.
The following four options have different specifics, but each option, if chosen by the employer, must be offered to all employees who are at least 21 years old and who have worked at least 1,000 hours in the previous year.
- Profit sharing. Profit sharing is one of the most flexible types of retirement plans from an employer. Only the employer can contribute to these plans, but it allows a business to make large contributions to its employee retirement funds if they have good years. However, there is no required annual employer contribution. There is, however, some paperwork involved in these plans. Each employee must get a seperate account and employers must document how the profits for each employee have been determined.
- Traditional 401(k). In a traditional 401(k) plan, employees defer part of their salary to a retirement fund pre-tax, but some plans allow for them to be made on a post-tax basis. Contributions made by an employer to a traditional 401(k) plan are also not taxed by the federal government and most state governments. Employer contributions may vest over time depending on plan terms. There is a yearly maximum employer/employee combined contribution. These plans require annual nondiscrimination testing. Compliance testing is nondiscrimination tests that check to make sure a company isn’t offering 401(k) plans to only their highly compensated employees and often require work on the part of an employer to perform. This is required because there is no mandatory minimum contribution on the part of the employer.
- Safe harbor 401(k). A safe harbor 401(k) plan eliminates the need for the IRS compliance tests of a traditional 401(k) plans. Employees are able to contribute a percentage of their salary each paycheck and there are mandatory employer contributions of at least 3% of employee contributions. There are maximum annual combined employer/ employee contributions.
- Automatic enrollment 401(k). Automatic enrollment will help an employer increase retirement plan participation, but employee can still opt out. There is a maximum annual combined employer and employee contribution. However since it is an automatic enrollment, the contribution rates are all set to a default. Employer contributions may vest over time depending on plan terms. These plans may require annual nondiscrimination testing.
Defined benefit plan
In a defined benefit plan, an employer is allowed to contribute more, and thus deduct more on taxes, compared to a defined contribution plan. Unlike a defined contribution plan, these plans are primarily funded by employer contributions.
There are two types of defined benefit plans: pensions and cash-balance plans.
- Pension benefits at retirement time are based on a formula using the length of time an employee worked at the company and his or her average salary.
- Cash-balance plans refer to a set percentage of an employee’s salary each year plus a set interest rate applied to his or her balance.
These plans may vest over time according to plan terms which means an employee might need to work at the company for a set number of years to receive the full amount. The employer is required to make an annual contribution based on plan terms. They must be offered to all employees at least 21 years old who worked at least 1,000 hours in a previous year. These plans tend to be more complex than traditional retirement funds so they might be more expensive to set up and maintain.
Questions to ask when considering retirement plans
- What am I trying to accomplish? If you’re trying to attract top talent to your business or be competitive with larger companies, you may want a plan that has a matching program. If you’re trying to promote fiscal responsibility among your employees, perhaps a more flexible matching program would work. What you want to accomplish may change based on the the cost of a retirement plan to your company.
- Have I talked to an advisor? Independent financial advisors can help you navigate the complicated retirement plan options to help find a provider or situation that’s the most cost effective for your small business.
- What will this cost my company? Administering a retirement plan can mean a lot of maintenance and cost because of the account services fees. When you’re thinking about retirement plan options, check if the plan is set up to charge asset-based fees or a flat fee. If it’s asset-based, as your company grows and you add more employees, your fees will also increase. They could also increase the more your employees contribute to the plan. You also want to determine what retirement plan fees you want your employees to take on.
- How will you maintain the plan? Do you have the ability and knowledge to run the retirement plan in-house, or do you need to hire an outside company to operate and maintain your retirement plan? Whether you handle the plan in-house or out, it will cost you additional time and money.
Offering an employee retirement plan might seem like an overwhelming or cost-prohibitive benefit, but it’s something that is highly valued by many employees. There are also more simplistic retirement plan options if you don’t want to spend a lot of time and money on setting up and maintaining a plan. If it’s something you can afford to do, it would likely be seen as very favorable by current or potential employees.
The IRS and the Department of Labor both offer additional resources to help you choose the right retirement plan for your business or help you maintain your plan.
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