Guide to Employee Retirement Plans for Small Business Owners
Small business owners have many retirement plan options to offer their employees. Previously rare, now just about any small business can offer retirement plans at an affordable rate supported by a robust marketplace of service providers.
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Everything Small Business Owners Need to Know About Retirement Plans
In this guide, we will discuss:
Why a small business should consider employee retirement plans
Ways a small business can prepare itself to offer employee retirement plans
The purpose of this guide is to equip small business owners with both high-level and tactical information on employee retirement plans. At the end of the guide, small business owners will understand the end-to-end process of offering retirement plans. Since every small business is different, it will be up to the business operator to ultimately decide which retirement plan is the best fit for its situation.
Why a small business should consider employee retirement plans
There are two main reasons why a small business should consider offering retirement plans to its employees. They are 1) to attract and retain talent, and 2) tax advantages. Let's unpack both of those two reasons:
Talent Attraction and Retention
Small employers now have all the same retirement plan options to offer their employees as do Mid-Market and Enterprise businesses. Having the ability to offer competitive retirement plan options levels the playing field for small businesses. Retirement plan options legitimize a small business in the eyes of top talent.
Small business retirement plans provide a lot of tax advantages and tax benefits for both employers and employees. They include:
Employer contributions are deductible from the employer's income tax return to the extent that the contributions do not exceed the limitations. For additional information on employer deduction limits, visit the IRS's publication 560 (which is prepared for 2021 but has guidance for 2022).
Employee contributions are deductible from the employee's income. You are providing your employees with a vehicle to lower their income tax obligations by diverting pretax dollars into retirement accounts.
Employee contributions (other than Roth contributions) are not taxed until distributed to the employee.
Money in retirement plans grows tax-free.
Distributions may be eligible for tax-favored rollovers or transfers into other retirement programs.
High contribution limits so both employer and plan participants can set aside large amounts of money for retirement.
Catch-up contribution rules allow employees to set aside additional contributions .The amount varies depending on the type of plan. Eligibility rules require the employee to be aged 50 and over.
A tax credit for small business owners enables them to claim a credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE, or certain other types of retirement plans. The credit equals 50 percent of the cost to set up and administer the plan, up to a maximum of $500 per year for each of the first 3 years of the plan.
A tax credit for certain low-income and moderate-income individuals (including self-employed) who make contributions to their plans ("Saver's Credit"). The amount of credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent, depending on the participant's adjusted gross income.
A Roth program can be added to a 401(k) plan to allow participants to make after-tax contributions into separate accounts, providing an additional way to save for retirement. Distributions upon death or disability or after age 59 1/2 from Roth accounts held for 5 years, including earnings, are generally tax-free.
Tax laws tend to change so make sure you stay on top of it. The information stated above in the tax advantages section might change. For more information on tax advantages and tax credits please visit the IRS's web page on Retirement Plans for Small Entities and Self-Employed.
Overview of the employee retirement plan landscape
Small business owners have a range of choices when it comes to the types of retirement savings plans they can offer their employees. There are generally three main categories of retirement plans and options within each of those categories. Let's take a look at each of the three categories and their associated options:
IRA plan options are:
Payroll Deduction IRA: If an employer does not want a retirement plan, they can still allow employees to contribute to an IRA through payroll deductions. The benefit is the employee decides whether, when, and how much in salary deferrals they want to contribute to the IRA. Currently, the contribution limits are $6,000 or $7,000 if age 50 or older. The two types of payroll deduction IRAs are a traditional IRA (employees contribute pre-tax dollars) and a Roth IRA (employees contribute after-tax dollars). There is no vesting schedule either, all funds contributed are the employees.
SEP: Employers (even those who are self-employed) can set up Simplified Employee Pension (SEP) IRAs for themselves and their employees. Although optional, typically employers contribute a standard percentage of pay for each employee. Contributions to a SEP can be made to participants over age 70½ (even those who are self-employed). Participants, age 72 or over (if age 70½ was attained after December 31, 2019) must take the required minimum distributions. For 2022, contributions can't exceed the lesser of 25% of the employee's compensation or $61,000. You can't consider part of an employee's compensation over $305,000.
SIMPLE: A SIMPLE IRA plan is for employers with 100 or fewer employees. Employees can contribute a percentage of their salary each paycheck and require employer contributions. Under SIMPLE IRA plans, employees can set aside up to $14,000 by payroll deduction. Employers must either match employee contributions dollar for dollar - up to 3% of an employee's compensation - or make a fixed contribution of 2% of compensation for all eligible employees, even if the employees choose not to contribute.
401(k) plan options are:
Safe Harbor: A safe harbor 401(k) plan works for businesses with highly compensated employees whose contributions would be limited in a traditional 401(k) plan. A safe harbor 401(k) plan allows employees to contribute a percentage of their salary for each paycheck and requires employer contributions. In a safe harbor 401(k) plan, the mandatory employer contribution is always 100% vested. For 2022, the deferral limit is $20,500 or $27,000 if you're 50 or older.
Automatic Enrollment: Automatic enrollment 401(k) plans are for employers who want a high level of participation. Employees are automatically enrolled in the plan and contributions are deducted from their paychecks, unless they opt-out. The default employee contribution rate may rise incrementally over the first few years, although employees are allowed to choose different amounts.
Traditional: With a traditional 401(k) plan sponsored by their employer, employees defer a portion of their salary. Each employee has separate deferrals, they are made on a pre-tax basis if the plan allows, and the employees can additionally make them on an after-tax (Roth) basis. Some 401(k) plans have employer matching or other one-time contributions. The Federal Government and most state governments do not tax employer contributions and pre-tax deferrals (plus earnings) until distributed. For 2022, the employees can make annual contributions up to the limit of $20,500.
Solo: Entrepreneurs with no employees can leverage a solo 401(k) for a retirement plan. As long as the small business has no employees, and is operated by a sole proprietor, the owner can contribute up to $61,000 for 2022 with an additional $6,500 for catch-up if 50 or older. With a solo 401(k) self-employed individuals are not at a disadvantage when it comes to their retirement.
Pension Plans / Defined Benefits Plans
Defined benefit plans, also known as a pension, have unique advantages. For example, businesses can contribute and deduct more each year than in defined contribution plans (i.e., 401ks and IRAs). The fixed benefit provided by pensions can be very beneficial to employees come retirement time, more so than under other types of retirement plans. Defined benefit plans are typically more complex to administer and more expensive to establish and maintain than other types of plans.
Profit Sharing Plans
When a small business makes contributions to a profit-sharing plan, they are usually discretionary. There is often no set amount that an employer needs to contribute each year. Typically small businesses use a formula to determine how the contributions are allocated to participants. The funds are accounted separately for each employee. Profit-sharing plan administration can be complex to administer and carry an administrative cost, but financial institutions offer profit-sharing plans that can reduce the administrative burden on individual employers.
Ways to offer employee retirement plans
In today's digital world it can be easy for a small business to set up and offer retirement plans. Most service providers will sync up directly with your payroll system. Let's look at two ways to go about it:
Direct from Retirement Plan Provider
There are traditional service providers such as Vanguard and Bank of America / Merrill Edge who can assist a small business with offering retirement plans. There are also newer players in this space that can assist. The most important thing here is to make sure the service provider offers the specific plan that you want to offer your employees. Here are some best practices to make sure you find the right service provider for you:
Conduct research online by typing searches like, "small business retirement plans for employees" into Google for a general list. If you happen to already know the type of retirement plan you want to offer, conduct your search using the plan name. These types of searches will yield results with many service providers.
Ask your professional network for suggestions. Having a strong business network can be very beneficial. If you are part of a local business group, you can ask the group for their recommendation on retirement plans. This should yield a better result than an internet search because you are likely going to get a recommendation from someone you know that has gone through this process in the past.
Your local town or city might have assistance programs offered by services like the Better Business Bureau, Chamber of Commerce, or even by a local business owners group, for you to educate yourself on employee retirement plans. They might host local events for you to attend in person, or offer online educational webinars.
Read online reviews and customer testimonials
Get a quote from several providers to ensure you wind up with the best service provider for your specific situation
When you select a service provider, you will work directly with them to set up retirement plans, payroll sync, management portal for employees, etc.
Professional Employment Organizations
More commonly referred to by its acronym, PEOs are a great way for small businesses to offer retirement plans. What exactly is a PEO and why would a small business owner consider joining one? A PEO is full-service human resource outsourcing, also known as co-employment. As a small business owner, if you join a PEO, you can offer retirement plans to your employees via the PEO (and other benefits like health insurance). It can be a tricky dynamic to understand at first, but your employees become co-employed by your company and the PEO provider. Since the PEO provider already has these offerings established, you can simply tap into their existing infrastructure to offer a range of employee benefits.
A PEO also executes various administrative tasks for the small business such as payroll and benefits administration, tax filing, compliance, talent services, and more. Essentially, with a PEO, a small business can shift critical HR tasks to the PEO which can help a small business owner focus on the business.
There are several PEO providers to research. Justworks, TriNet, and Insperity are just some popular choices that small business owners can consider. A PEO also provides modern technology and support to administer their retirement plan benefits - which a small business might not have access to. For example, with Justworks, subscribers have access to an online platform so employees can easily enroll and manage retirement plan selections.
Certain small business retirement plans can be setup and administered directly with the U.S. Government. For example, for a SIMPLE IRA, you may use IRS Form 5304-SIMPLE or 5305-SIMPLE to set up the plan. For more information, visit the IRS's web page on Retirement Plans for Small Entities and Self-Employed.
Ways a small business can prepare itself to offer employee retirement plans
The question on every small business owner's mind is, "how am I going to pay for this?" Before a small business should offer retirement plans to its employees, it should review its finances and prepare itself for the added expense. This can mean improving cash flow, consolidating debt, bolstering cash reserves, and more. Here are two tactics a small business can use to best prepare itself for the added expense of offering retirement plans: 1) improve and optimize cash flow and/or 2) by obtaining capital from a lender to improve and optimize business operations. Let's dive into these two tactics:
Cash flow: Small businesses with strong cash flow will be in a better position to offer retirement plans. For additional tips on cash flow, read our article titled Smart Ways to Increase Cash Flow with Small Business Financing.
Funding from a Small Business Lender: Whether from a traditional financial services institution or an online lender, there are many options to obtain capital which can be used to improve and optimize business operations. Businesses that are running smoothly will be in a better position to offer retirement plans. Below are some common loan and options and how they can be used to manage the business operations:
Working Capital: working capital loans can get a small business the capital support it needs. With a working capital loan, a small business can use the proceeds to grow the business, cover one-time business expenses, hire staff, buy new equipment, pay down operational costs, purchase inventory, expand its workplace, and more.
Term Loans: term loans give established businesses the financing needed to grow. Some popular reasons small businesses seek term loans are growth and expansion, access to full cash amount upfront, use for a broad range of business needs, free up operational cash flow, and benefit from tax-deductible interest.
ERTC Loans: Employee Retention Tax Credit loans are interest-only. An ERTC loan gives business owners waiting on an IRS credit payment access to more of their funds up front without the wait. A small business can use the funds for any purpose it needs. For example, growth and expansion, access to full cash amount upfront, use for a broad range of business needs, free up operational cash flow, and benefit from tax-deductible interest.
Small Business Credit Card: Not a loan, but a business credit card can be used to manage the expenses associated with administering your retirement account. For example, a retirement plan service provider might charge a monthly fee, a one-time setup fee, etc.
Small Business Line of Credit: A business line of credit is similar to a credit card. Lenders will establish a credit limit for the maximum amount of money they will lend you and you can tap as much as you need up to your limit. Like a credit card, you pay interest only on the amount you borrow and the proceeds can be used to manage the expenses associated with administering your retirement account.
SBA 7(a) Loans: The SBA 7(a) loan program is the SBA's most common loan program which includes financial help for small businesses with special requirements. This is the best option when commercial real estate is part of a business purchase, but it can also be used for short-term and long-term working capital, refinance current business debt, and purchase furniture, fixtures, and supplies.
SBA Microloans: The SBA microloan program provides loans up to $50,000 to help small businesses and certain not-for-profit childcare centers start up and expand. The average microloan is about $13,000.
These options can position a business to best handle the administrative cost and any contributions they might add to employee retirement plans. Your employees of course will need to contribute to the program on their own.
Small businesses should consider offering employee retirement plans to attract and retain talent, and so both employer and employee can take advantage of various tax breaks. With a variety of implement tactics to choose from, small business owners can confidently offer retirement plans on par with larger companies. Leveraging the information in this guide will help position your small business for the added expense of offering retirement plans to your employees. For additional information on how to get access to financing, contact Biz2Credit today.
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