Laurence Hale, AAMS®, CRPS®
Principal/Managing Partner, Investment Advisor & Chief Investment Officer
As a business owner, establishing an employer-sponsored retirement plan can provide you with a tax-advantaged method to save funds for your own retirement, while providing your employees with a powerful and appreciated benefit – helping you all to build wealth so you can live well when you retire. There are several types of retirement plans to choose from, each with its own advantages and drawbacks to consider.
Here’s an overview of some of the most popular plans to help get you started on deciding which might be the best option for you and your business...
Traditional 401(k) plans are generally less costly than other retirement plans, but are also more complicated.
401(k) plans are by far the most popular type of plan. They allow contributions to be funded by the participants themselves, rather than by the employer. Employees can choose to contribute (or “defer”) a portion of their salary and have it put in the plan instead.
These plans may be expensive to administer, but the employer contribution cost is generally very small (though you may choose to match employee deferrals), so in the long run 401(k) plans tend to be relatively inexpensive for you as the business owner. The requirements for 401(k) plans are complicated though, and several tests must be met for the plan to remain in force. For example, the higher-paid employees' deferral percentage cannot be disproportionate to the rank-and-file's percentage of compensation deferred.
Safe harbor, QACA and SIMPLE 401(k) plans are less complicated, but may be more costly.
You don't have to meet the same types of requirements and tests associated with a traditional 401(k) plan if you choose to adopt any one of a number of special types of 401(k) plans instead. These include a “safe harbor” 401(k), a qualified automatic contribution arrangement (or QACA), or a SIMPLE 401(k) plan. The potential drawback to these types of 401(k) plans is that they all require you as the employer to make a contribution to your employees’ accounts in varying degrees, making them potentially more costly.
An individual, or “solo,” 401(k) plan may be a good fit for you if you have no employees or your spouse is your only employee.
Because you have no employees, you won't need to perform discrimination testing, and your plan will be exempt from the requirements of the Employee Retirement Income Security Act of 1974 (ERISA). You can make pre-tax contributions of up to $19,500 in 2021, plus an additional $6,500 of pre-tax catch-up contributions if you're age 50 or older. You can also make profitsharing contributions; however, total annual additions to your account in 2021 can't exceed $58,000 (plus any age-50 catch-up contributions).
Profit-sharing plans offer tax-deductible contributions that can flex with the profitability of your business.
Profit sharing plans allow you, as an employer, to make a contribution that is spread among the plan participants. A separate account is established for each plan participant, and contributions are allocated to each participant based on the plan's formula (which can be amended from time to time). Each participant's account must also be credited with his or her share of investment income (or loss).
You as the business owner must make contribution to the plan on a regular basis but you are not required to make a set annual contribution in any given year, allowing you flexibility to contribute based on profitability. Your total deductible contributions in any given year may not exceed 25% of the total compensation of all the plan participants in that year, however, and the amount of compensation you can include for each individual in that calculation is capped – in 2021, the limit is $290,000. The contribution limit for each individual’s account is also capped – in 2021 it’s $58,000 or 100% of his or her earnings for the year, whichever is less.
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Money purchase pension plans are similar to profitsharing plans, but an annual defined contribution is required.
These plans also establish separate accounts for each plan participant, with the same contribution and deductible limits as a profit-sharing plan. However, they are less popular because an annual contribution, defined as a percentage of each employee’s annual compensation, is required.
Defined benefit plans may offer the largest deduction and highest retirement benefit to business owners.
Defined benefit plans set out a formula that defines how much each participant will receive annually after retirement if he or she works until retirement age. This is generally stated as a percentage of pay, and can be as much as 100% of final average pay at retirement. An actuary certifies how much will be required each year to fund the projected retirement payments for all employees. The employer then must make the contribution based on that determination.
Unlike defined contribution plans, there is no limit on the contribution. The employer's total contribution is based on the projected benefits. Therefore, defined benefit plans potentially offer the largest contribution deduction and the highest retirement benefits to business owners.
SIMPLE IRA retirement plans offer many of the same features as 401(k) plans without the testing requirements – but they do have drawbacks for business owners.
A SIMPLE IRA is actually a sophisticated type of individual retirement account (IRA) that can be utilized by employers with 100 or fewer employees. SIMPLE stands for Savings Incentive Match Plan for Employees. Like a 401(k), this plan allows employees to defer a certain amount of annual compensation by contributing it to an IRA. Unlike a traditional 401(k), SIMPLE IRAs do not have testing requirements, so they're cheaper to maintain. But, employers are required to match deferrals up to 3% of the contributing employee's wages, or make a fixed contribution of 2% to the accounts of all participating employees whether or not they defer to the SIMPLE plan.
There are also a number of drawbacks for you as the business owner to consider. First, all contributions are immediately vested, meaning any money contributed by the employer immediately belongs to the employee (employer contributions are usually "earned" over a period of years in other retirement plans). Second, the amount of contributions the highly paid employees (usually the owners) can receive is severely limited compared to other plans. Finally, the employer cannot maintain any other retirement plans.
Finding the right plan for you and your business can be tricky, so work with a professional.
If you’re considering a retirement plan for your business, ask a plan professional to help you determine what works best for you and your business needs. The rules regarding employer-sponsored retirement plans are very complex and easy to misinterpret, and even after you’ve decided on a specific type of plan you will often have a number of options in terms of how the plan is designed and operated. These options can have a significant impact on the number of employees that have to be covered, the amount of contributions you have to make, and the way those contributions are allocated (for example, the amount that is allocated to you, as an owner).
At Weiss, Hale and Zahansky Strategic Wealth Advisors we use our proprietary Plan Well, Invest Well, Live Well™ strategic process to help business owners get set up for financial success both personally and professionally at every stage of their journey, from retirement planning to succession planning. See how we can help you and your business.
Presented by Principal/Managing Partner Laurence Hale, AAMS, CRPS®. Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2021. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259, 860-928-2341. http://www.whzwealth.com (http://www.whzwealth.com).