New Business? It’s a Good Time to Think About Retirement Plans
- Learn more about the pros and cons of defined benefit pension plans.
- Find out if defined contribution plans have more advantages for you and your employees.
- Discover the benefits of SEPs and SIMPLEs.
Have you recently launched a business? You may want to think about tax-favored retirement plans for yourself and your employees. There are several types of qualified plans eligible for these tax advantages:
- A current deduction from income to the employer for contributions to the plan,
- Tax-free buildup of the value of plan investments, and
- The deferral of income (augmented by investment earnings) to employees until distribution of funds.
Fiducial has the information you need about the two basic types of plans.
Defined benefit pension plans
A defined benefit plan provides for a fixed benefit in retirement, based generally upon years of service and compensation. While defined benefit plans generally pay benefits in the form of an annuity (for example, over the life of the participant, or joint lives of the participant and his or her spouse), some defined benefit plans provide for a lump sum payment of benefits. In certain “cash balance plans,” the benefit is typically paid and expressed as a cash lump sum.
Adoption of a defined benefit plan requires a commitment to fund it. If the business owners are nearing retirement, these plans often provide the greatest current deduction from income. They also provide the greatest retirement benefit. However, the administrative expenses associated with defined benefit plans (for example, actuarial costs) can make them less attractive than the second type of plan.
Defined contribution retirement plans
A defined contribution plan provides for an individual account for each participant. Benefits are based solely on the amount contributed to the participant’s account and any investment income, expenses, gains, losses and forfeitures (usually from departing employees) that may be allocated to a participant’s account. Defined contribution plans include profit-sharing plans and 401(k)s.
A 401(k) plan provides for employer contributions made at the direction of an employee under a salary reduction agreement. Specifically, the employee elects to have a certain amount of pay deferred and contributed by the employer on his or her behalf to the plan. Employee’s can make contributions either:
- On a pre-tax basis, saving employees current income tax on the amount contributed, or
- On an after-tax basis. This includes Roth 401(k) contributions (if permitted), which will allow distributions (including earnings) to be made to the employee tax-free in retirement, if conditions are satisfied.
Automatic-deferral provisions, if adopted, require employees to opt out of participation.
An employer may, or may not, provide matching contributions on behalf of employees who make elective deferrals to the plan. Matching contributions may be subject to a vesting schedule. While 401(k) plans are subject to testing requirements, so that “highly compensated” employees don’t contribute too much more than non-highly-compensated employees, these tests can be avoided if you adopt a “safe harbor” 401(k) plan. Highly compensated employees (in 2020) earned more than $130,000 in the preceding year.
There are also other types of tax-favored retirement plans within these general categories, including employee stock ownership plans (ESOPs).
Other retirement plans
Small businesses can also adopt a Simplified Employee Pension (SEP), and receive similar tax advantages to “qualified” retirement plans by making contributions on behalf of employees. And a business with 100 or fewer employees can establish a Savings Incentive Match Plan for Employees (SIMPLE). Under a SIMPLE, generally, each employee has an IRA established for them. Then, the employer makes matching contributions based on contributions elected by employees.
Would you like to learn more about these or other retirement plan options? Contact us to discuss the types of retirement plans available to you. Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations. Ready to book an appointment now? Click here. Know someone who might need our services? We love referrals!
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