Offering retirement plans as a small business can help you attract and keep talent, incentivize employees to stay longer, and save you money on both personal and business taxes.
Setting up retirement plans is easier than it may sound, but like all things in life, there are pros and cons. There are four plan options that are easy enough for a small business to offer and strong enough when it comes to engaging talent with competitive benefits.
The Four Types of Employee Retirement Plans for Small Businesses
There are four main types of employee retirement plans that are easy for a small business to offer including:
- SEP IRAs
- SIMPLE IRAs
- 401(k)
- Profit Sharing
Simplified Employee Pension (SEP) IRA
Simplified employee pension or SEP IRAs are inexpensive for small business owners to set up, and the employer makes all of the payments into the account. It’s as easy as using this form to establish the plan, notifying all employees about the plan, and following the instructions on the IRS website here for each eligible employee.
There are restrictions to participating, like the employee having to be 21 years of age and needing to have worked for your company for at least 3 of the last 5 years. There are also advantages like a simplified contribution model. The amount contributed is a percentage of the employee’s salary or a flat fee, and there is a limit on the total amount that can be contributed.
These plans have the most expensive matching rules for employees, which can be costly as your business expands. Fortunately, there is some flexibility: you are not required to add money every year to a SEP IRA, and not all team members will qualify for contributions. Although employees can opt out, immediate vesting (which lets the employee have immediate ownership of the retirement account) is a big incentive for them.
Pros:
- Low cost to establish
- Easy to manage and contribute to
- Immediate vesting
Cons:
- No flexibility with the amount (everyone gets the same rate including you)
- Employees cannot contribute, only the employer
- No ROTH (after tax) option to contribute to the plan
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a moderate-cost workplace retirement plan that allows both employers and employees to contribute, making it more appealing than the SEP IRA. Much like a SEP IRA, you are able to set it up yourself or use a broker.
Although you do need to provide matching contributions for employees with the SIMPLE IRA, the percentage is not as high as the contribution you’re responsible for paying with a SEP IRA. However, there’s not as much flexibility because you need to provide money for employees every year.
The plan is only available for companies with 100 or less employees, so it is designed for small and medium-sized businesses, making it much easier to manage than complex retirement plans.
If members of your workforce are 50 years old or older, they can make catch up contributions, which may be a factor that helps you retain experience and talent on your team. Much like the 401(k) plans where there is a larger catch-up amount for people ages 60+, employees who are nearing retirement may stick around longer knowing they have a way to cross the finish line with a safety net.
Pros:
- Easy to set up and manage, and no filing requirements
- Employer contributions are tax deductible
- Immediate vesting
Cons:
- Employer contributions are mandatory, even when you have bad years
- You must choose one of two models and stick with them
- Employees pay taxes on early withdrawals
- Companies cannot offer any other retirement plan options if they offer a SIMPLE IRA
401(k)
401(k) plans are the most expensive to set up and administer, but they allow employees to contribute a portion of their compensation to the account. Based on how you set it up, they can contribute pre-tax or after tax with a ROTH option.
The more employees you have, the more a 401(k) makes sense because you can spread the high fixed costs across more people. These plans don’t require matching, so you can set up a 401(k) with a no match option, making it flexible for you as a business owner.
There are three main types of 401(k) plans that make sense for small businesses including the traditional one, a safe harbor where the employer makes the minimum contributions to the account via matching or non-elective, and the solo 401(k) which is only available if the business owner is the only company employee. Solo 401(k) plans allow the business owner to contribute as an employee and the company to contribute as an employer.
Pros:
- These plans normally allow for higher contributions compared to SIMPLE IRAs.
- You have flexibility in the plan with vesting schedules, profit sharing, and matching.
- Employees can borrow from them if they need money.
- They’re attractive to potential employees, making recruitment easier.
- Employees can choose how much to contribute.
Cons:
- There is more paperwork and effort that goes into 401(k) plans compared to IRAs, so you’ll likely need a consultant or manager.
- You will be required to perform non-discrimination tests to ensure contributions are fair.
- There are higher fixed costs compared to IRAs.
- There are more rules and restrictions, including from the IRS and Department of Labor.
Profit Sharing Plans
Profit sharing plans can be combined with 401(k) retirement plans, offering a lot of flexibility. But when they’re not combined, the employer is responsible for contributing a portion of profits to the retirement accounts. Although there are limits set by the IRS, employers can choose how much to contribute and opt out of contributing if they do not want to, as long as they do not opt out on a regular/consistent basis.
There is a considerable amount of paperwork and management required like with a 401(k), including a written plan outlining the profit-sharing strategy, disclosures being provided to employees, and the employer needing to keep detailed and accurate records. During years where the employer does contribute, they can decide to go larger or smaller depending on how much profit was earned and how much they need to invest back into the company.
Business owners have more flexibility to compensate individual employees based on seniority within the company, service to the company, and age. If you want to attract experienced talent, this type of retirement plan may be more appealing than SEP IRAs.
Pros:
- They can be combined with other types of retirement accounts.
- There’s flexibility to contribute based on individual employee contribution, value, and service to the company.
- Employers can opt out of making contributions during bad financial years.
Cons:
- There is a lot more paperwork and record keeping than with other small business retirement plans.
- Non-discrimination testing takes time and can be costly if you’re found in violation of the regulations. You can find a good overview on page 5 of this document.
- Strict deadlines and funding rules must be followed, even though you can opt out of certain years.
There are other options like a pooled employer plan or a cash balance plan, but these get more complex to manage and maintain. Additionally, pensions can make sense for medium-size and larger companies. They’ll require someone to make and monitor the investments while ensuring there are monthly payouts for team members who have retired.
This may be too much work and too expensive for most SMB owners, which is why the four options above tend to be the best ways to offer an employee retirement plan for small businesses. And offering these types of plans can make running a small business easier.
The Pros and Cons of Offering a Retirement Plan
There’s always going to be good and bad when you make a shift in company policies. You could attract better talent, but there could be more administrative costs or time spent on new programs.
Retirement plans tend to be in the group where the benefits outweigh the negatives, so here’s a few to help you decide if your small business should offer a retirement plan.
The Pros of a Retirement Plan for Employees
Offering a retirement plan for your employees has benefits for yourself and your business including:
- Corporate and personal tax savings depending on the plan.
- An easier time recruiting new employees as this is a sought-after perk.
- Helping the business owner to retire more easily.
The first benefit for employers is the tax breaks as contributions are tax deductible including 401(k) contributions which you can learn about here. Employees can also save on their taxes by contributing pre-tax or by contributing post-tax and having the money grow tax-free. The IRS has details here on how this works if you’d like to share with your team.
Employees want to know that their current life and future are taken care of, and having a retirement plan in place shows that you as an employer have thought about this and will be helping them reach their goals. In addition, having an employer-based retirement plan option lets you as a business owner begin saving tax-free and enjoying tax deductions so you can retire one day as well.
The Cons of Offering Employee Retirement Plans
There are negatives with offering employee retirement plans including:
- Having to share profits or spend revenue that could have been reinvested into growth.
- Adding costs like an investment broker, service provider, administrative fees, and a team member to manage the program.
- Time lost having to do extra paperwork for the IRS or in meetings with your accountant to ensure all processes are fair and contributions are done correctly and within regulations.
Retaining employees is always good for business as it is expensive to replace them and there will be a break in productivity as new team members get trained. But the money you save by contributing to their retirement could be spent upgrading equipment, paying for marketing and advertising to bring customers in, or buying real estate for a new location and adding to your company’s assets.
You’ll likely need to hire an investment broker or manager, pay your accountant for additional work when it’s tax time, and spend more time each year making sure contributions are correct. This is time and money that could be used elsewhere if you don’t offer a retirement option for employees.
With that said, working capital loans can offset some cashflow gaps as they can be used for payroll, rent, equipment repairs, and other short-term costs when cash is tight because you’re making contributions.
Small businesses can offer retirement savings plans to their employees fairly easily through SEP IRAs, SIMPLE IRAs, 401(k) plans, and profit sharing. Each one comes with costs and additional administrative work, but they can also keep employees motivated to stay with your company, help you on your own path to retirement, and save you and your company on taxes. It’s fairly easy to launch a program, and you can get a small business loan to fill cash flow gaps during contribution time.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
