Question:
I'm a small employer with 25 employees. I've considered starting a retirement plan for my workers, but I don't want to do anything complicated. Are there simple options for employers like me?
Starting a small business retirement savings plan can be easier than most business people think.There are a number of retirement options that provide tax advantages to both employers and employees.
By starting a retirement savings plan, you will be helping your employees save for the future. Retirement plans may also help you attract and retain a qualified pool of employees. What's more, you will be joining more than one million small businesses with 100 or fewer employees that offer workplace retirement savings plans.
Why save?
Experts estimate that Americans will need 60 to 80 percent of their pre-retirement income -- lower-income earners may need up to 90 percent to maintain their current standard of living when they stop working. So, now is the time to look into retirement plan options. As an employer, you have an important role to play in helping America's workers save.
Most private-sector retirement plans are either defined benefit plans or defined contribution plans. Defined benefit plans promise a specified benefit at retirement, for example, $100 a month at retirement. The amount of the benefit is often based on a set percentage of pay multiplied by the number of years the employee worked for the employer offering the plan. Employer contributions must be sufficient to fund the promised benefit.
A defined contribution plan, on the other hand, does not promise a specific amount of benefit at retirement. In these plans, employees or their employer (or both) contribute to employees' individual accounts under the plan, sometimes at a set rate (such as 5 percent of salary annually). A 401(k) plan is one type of defined contribution plan. Other types of defined contribution plans include profit-sharing plans, money purchase plans, and employee stock ownership plans.
Small businesses may choose to offer a defined benefit plan or any of these defined contribution plans. Many financial institutions and pension practitioners make available both defined benefit and defined contribution "prototype" plans that have been pre-approved by the IRS.
This brochure focuses on a few of the simpler options — SIMPLE plans, SEPs, 401(k) plans, profit-sharing plans, and payroll deduction IRAs.
All retirement plans have important tax, business and other implications for employers and employees. Therefore, you may want to discuss any retirement savings plan with a tax or financial advisor.
Here's a brief look at some plans that can help you and your employees save.
SIMPLE: Savings Incentive Match Plans for Employees of Small Employers
This savings option for employers of 100 or fewer employees involves a type of individual retirement account (IRA) and is the result of new legislation, the Small Business Job Protection Act of 1996.
A SIMPLE plan allows employees to contribute a percentage of their salary each pay check and to have their employer match their contribution. Under SIMPLE plans, employees can set aside up to $6,000 each year by payroll deduction. Employers can either match employee contributions dollar for dollar -- up to 3 percent of an employee's wage -- or make a fixed contribution of 2 percent of pay for all eligible employees instead of a matching contribution.
SIMPLE plans are easy to set up -- you fill out a short form, administrative costs are low, and much of the paperwork is done by the financial institution that handles the SIMPLE plan accounts. Employers may choose either to permit employees to select the IRA to which their contributions will be sent, or to send contributions for all employees to one financial institution (which will forward contributions of employees who elect a different IRA). Employees are 100% vested in contributions, get to decide how and where the money will be invested, and keep their IRA accounts even when they change jobs.
A SEP allows employers to set up a type of individual retirement account — known as a SEP-IRA— for themselves and their employees. Employers must contribute a uniform percentage of pay for each employee. Employer contributions are limited to the lesser of 15 percent of an employee's annual salary or $24,000. (Note: this amount is indexed for inflation and will vary). SEPs can be started by most employers, including those who are self-employed.
SEPs have low start-up and operating costs and can be established using a single quarter-page form. Businesses are not locked into making contributions every year. You can decide how much to put into a SEP each year -- offering you some flexibility when business conditions vary.
401(k) plans have become a widely-accepted savings vehicle for small businesses. Today, an estimated 25 million American workers are enrolled in 401(k) plans that hold total assets of about $1 trillion.
Employees contribute a percentage of their pay to the 401(k) plan on a tax-deferred basis through payroll deductions. Employers also may contribute to an employee's 401(k) account by matching employee contributions, usually up to a percentage of an employee's pay. The maximum amount an employee can deposit to a 401(k) is indexed for inflation. In 1997, that amount is $9,500.
While more complex, 401(k) plans offer higher contribution limits than SIMPLE plans and IRAs, allowing employees to accumulate greater savings.
Employers also may make profit-sharing contributions to a plan that are unrelated to any amounts an employee chooses to contribute. The amount of these contributions is often set as a percentage of employees' pay; however, the employer can change the percentage or amount from year to year. A plan may combine these profit-sharing contributions with 401(k) contributions (and matching contributions).
Even if an employer does not want to adopt a retirement plan, it can allow its employees to save through payroll deduction, providing a simple and direct way for eligible employees to contribute to an IRA. This type of payroll deduction system is not generally considered a pension plan, provided that the decision of whether to contribute, and when and how much to contribute to the IRA (up to $2,000) is made by the employee.
Many individuals eligible to contribute to an IRA do not. One reason is that some individuals wait until the end of the year to set aside the money and then find that they do not have sufficient funds to do so. Payroll deductions allow individuals to plan ahead and save smaller amounts each pay period. Payroll deduction contributions are tax-deductible by an individual to the same extent as other IRA contributions.
The following two pamphlets and other pension-related publications are available from the Pension and Welfare Benefits Administration:
Simplified Employee Pensions (SEPs) - What Small Businesses Need to Know
Savings Incentive Match Plans for Employees of Small Employers (SIMPLE) - A Small Business Retirement Savings Advantage
Contact the Publication Hotline or Internet address for copies:
Publication Hotline: 1-800-998-7542
(also request a list of publications here)
Internet address: http://www.dol.gov/dol/pwba