Why retirement plans remain a good deal
Ever since the economy tanked in 2001, a lot of people began to hate retirement plans.
I can't tell you how many of my tax clients, when I asked if they wanted to put money into an IRA or other retirement plan, said to me, "No. All the plan has done is lose money. Or the plan has hardly made any money. Why would I add to it?"
The thing is, retirement plans themselves are still a great deal. The investments held in many of those plans haven't done well, but the plans themselves — the shell within which the investments are placed — are still sound. Employers as well as employees should remember this.
Retirement plans give employees the chance to set aside some of their wages tax-deferred, producing an immediate benefit in terms of reducing current taxable income and income taxes.
Employers get something out of the deal as well. No employee benefits package today is considered complete without some type of retirement plan. At a relatively modest cost, employer-provided retirement plans can improve overall company morale and make a business more attractive to current and potential employees.
The fact of the matter is, if you don't have a retirement plan for your employees, you likely will lose them to an employer who does. The same is true if you have a bad plan, a limited plan or a plan in which you choose not to match the employee's contribution. Employees today see a retirement plan as an essential part of their pay package.
In my business as a tax professional, I still get a lot of questions about retirement plans and which are the best ones for small businesses.
Here's a look at the most preferred plans for businesses with anywhere from two to 25 or more employees:
1. 401(k) plansThis is probably the best-known type of employer-sponsored plan, and the amounts that employees can put into this plan have been increasing. In 2004, an employee can set aside as much as $13,000 of his or her salary, or $16,000 if the employee is 50 or older.Employers can offer these plans without matching any contributions employees make to the plan. However, providing some kind of match can increase employee participation in the plan (and employee morale). That can be important because the amount a business owner or manager puts into a plan indirectly influences how many employees participate.Employees don't automatically have access to the money that employers contribute to these plans. Vesting rules can require that employees work for the employer for a particular amount of time before being entitled to employer contributions that have been made to the plan.
2. SIMPLE plansThe Savings Incentive Match Plan for Employees (SIMPLE) lets you put aside as much as $9,000 in 2004, or $10,500 if you're 50 or older.Employers have two choices of how to make contributions for their employees. The first option is to make a contribution of 2% of salary for all eligible employees, regardless of whether the employee participates in the plan. The other choice is to match, dollar for dollar, each participating employee's deferral, for up to 3% of his or her wages. So, for example, if an employee making $40,000 put aside $2,000, the employer would contribute an additional $1,200 (3% of the employee's $40,000 salary).But the employer choosing this option doesn't have to make any contributions for employees who decide to not have any wages deferred.
3. SEP plansWith a Simplified Employee Pension (SEP) plan, an employer can make a contribution of up to 20% of his or her income, to a maximum of $41,000, to a retirement plan. However, the employer has to make the same percentage contribution on behalf of all qualifying employees.The combination means that SEPs, despite their relatively low cost and simple structure, are often not the first option for many small businesses. They are, however, popular with the smallest businesses — operations in which the owner is the only employee. Without having to worry about matching contributions for employees, sole proprietors can use this plan to set aside anywhere from nothing to 20% of their income annually, and can change the amount they contribute each year without restriction.
Costs and credits for these plans
The cost of setting up and administering these plans can vary. Generally, SIMPLEs and SEPs will be least expensive; some brokerages and other financial institutions charge $50 or less per plan participant.
A 401(k) plan tends to be more expensive. Doug Van Allen, a certified financial planner and president of Marathon Wealth Management in Portland, Ore., says that annual charges of $750 to $1,500 for a small business's 401(k) are not unusual, plus a small per-employee fee. "It's a plan that has more administrative responsibilities," he says. "You have to take the contributions and put them correctly into a pooled account, there are Form 5500 [an IRS tax form] filings, discriminatory testing standards have to be reviewed. It's just a more complicated process."
"Because of their relative ease and lack of paperwork, the SIMPLE plans tend to be more popular with small businesses setting up a new retirement plan," Van Allen says. "There is no discrimination testing and the annual paperwork is simpler. Many small businesses see it as being just an easier option."
A relatively new tax break also eases some of the pain for any employer with fewer than 100 employees who sets up a retirement plan. The break is in the form of a tax credit for up to 50% of the cost of setting up a plan, to a maximum credit of $500. In addition, the other costs and contributions associated with these plans are deductible business expenses.