Weighing Retirement Plans
Its a balancing act: Offering a retirement plan to meet the needs of the company and employees.
One of the most difficult challenges facing all businesses, large or small, is dealing with employee benefits. After all, the mix of benefits you devise can have a serious impact on your hiring and employee retention, your general efficiency (because if you have a high employee turnover, your workflow will likely suffer), and your company's profitability.
Of the various types of benefits offered by employers, one of the most critical to your employees is probably the retirement plan. This is particularly true in today's economy, where employers are feeling more and more pressure to offer competitive retirement plans to their workforce. And because employees tend to be more mobile these days and want to take retirement plans with them when/if they go, employers have to offer a better mix of retirement- plan options. Whether you need to assess your current plan or you're evaluating the possibility of adopting a plan, it's important that you consider all your options. To help you do so, I'll address various plans here. Note that while some retirement plans authorized by the IRS in past legislation continue to function, they may no longer be adopted. For our purposes, I'll discuss only the plan types that can still be adopted as new plans.
Individual retirement accounts
Three types of individual retirement accounts or IRAs are available. The first is a Payroll Deduction IRA. Under this type of plan, employees authorize the employer to deduct a specified amount from their payroll check, which deposits directly into an IRA that the employee has set up. The type of IRA can be either a traditional IRA or a Roth IRA:
- A traditional IRA's contribution is tax deductible, either in whole or in part, depending on IRS limitations based on your adjusted gross income. The amounts earned in the employee's IRA are not taxable until they are distributed at a later eligible retirement date.
- The Roth IRA works just the opposite. The contribution is not tax deductible, but the distributions of earnings made at a later eligible date are not taxable as earnings.
The next type of IRA is a Simplified Employee Pension Plan (SEP). This type of IRA plan allows employers to make contributions directly into their employees' IRA accounts, as well as the employer's own IRA account. Under this type of plan, only the employer can contribute.
The last type of IRA is a Savings Incentive Match Plan for Employees (SIMPLE IRA). This plan was developed for small employers to set up salary-reduction contributions and add matching contributions from the employer directly into the employee's IRA account. Like the SEP, employers may also contribute to their own IRA account.
For small businesses, the 401(k) plan has become the most widely accepted retirement savings plan. The 401(k) plan is similar to a Roth IRA in that contributions are not taxed until distribution at a later date.
They are, however, much more flexible with regards to the amounts that can be contributed by an employee into their account"? up to $14,000 in 2005 and $15,000 in 2006. Employers can adopt various scenarios for matching on a percentage basis or a fixed dollar amount (all done on a discretionary basis), and can set up their own rules as to when an employee vests in the employer contributions. Of course, all contributions by the employee are immediately vested under the regulations.
If you are interested in establishing a 401(k) plan, it's wise to typically enlist the help of a benefits expert or discuss your options with a tax professional. While there are various ways to set up a 401(k), if you establish a "prototype plan" as defined by the IRS, your management fees will be significantly less and the filing requirements by the IRS will be much simpler.
Profit-sharing and money-purchase plans
Under a profit-sharing plan, employers contribute to profit-sharing plans on a discretionary basis. As implied in the title, the contributions are made based on excess profits as deemed by the employer. While the amount contributed is discretionary, the plan must follow a set formula as to how the profits are distributed each time amounts are contributed to the plan. As with the 401(k) plans, you will save time and money by adopting a "prototype plan" as set forth by the IRS.
A money-purchase plan, referred to as a "defined contribution plan," differs from other plans in that the employer makes "pre-defined" contributions to the plan. For example, the plan could require a 5% contribution of each eligible employee based on the employee's pay. In that respect, it is not a discretionary contribution; it is defined.
These types of plans can be advantageous because: they can be held in addition to other retirement plans; they can be for a business of any size; and they can be as simple or as complex as you wish. Like the 401(k) and profit-sharing plans, there are pre-approved money-purchase plans available that will save the employer time and money in filing requirements. Limitations of this type of plan are the lesser of 25% of compensation or $42,000 in 2005.
Defined benefit plan
This is the most complex and costly type of retirement plan. For this reason, the use of this type of plan has declined over the past years as more flexible and less-expensive plans have become available.
As implied in its name, this type of retirement plan guarantees the employee a specific return upon retirement, usually as a fixed dollar amount based on the employee's salary and service. The advantages of this type of plan are that larger amounts can be contributed (and therefore deducted) by the employer, vesting can be immediate, the plan can be used as a tool for early-retirement packages, and the future cash outlay is known to the business because it is a fixed amount. The disadvantages involve the high cost and complexity of maintaining this type of plan.
Two good sources
Although I've only provided a brief synopsis of the primary types of retirement plans available, you at least get a flavor of the numerous choices offered. If you're seeking further research on retirement plans, two good sources include: the IRS (www.irs.gov/retirement/index.html) and the US Department of Labor (www.dol.gov/dol/topic/retirement).
Marty McGhie (email@example.com) is VP finance/ operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations.