As a business owner, one of the best ways you can attract and maintain key employees who will help you grow your business is by offering a retirement plan as part of your benefits package. Selecting the plan that best suits your business is dependent on the number of employees and what type of savings options you’d like to have in place. Here are six types of retirement plans that will provide tax-deferred benefits and will also lower your taxable income.
Simplified Employee Pension Plans (SEPs)
- SEP IRAs are available to any small business owner with one or more employees or self-employed individuals. They are easy to establish and offer many of the same investment options as traditional IRAs.
- Employers (rather than employees) make contributions to the SEP IRA, so contributions are only tax-deductible for the employer. Business owners can choose whether or not to make a contribution every year, but if contributions are made, they must be proportional among all employees. In general, an employer must include all employees who have (1) reached age 21, (2) worked for them for at least three of the last five years, and (3) received a minimum amount of pay (at least $600 for 2019) for the year the contribution was made.
- SEP IRAs feature much higher annual contribution limits compared to other IRAs. Employers may deduct the lesser of contributions paid to an employee or 25% of the employee’s compensation (the lesser of that figure or $56,000).
- SEP IRAs are subject to the same guidelines as other IRAs, such as required minimum distribution starting at age 70 ½ and early withdrawal penalties for withdrawals before the age of 59 ½.
SIMPLE IRA Plan
- Business owners with 100 or fewer employees who earn $5,000 or more meet the qualifications for establishing a SIMPLE IRA plan.
- SIMPLE stands for Savings Incentive Match Plan for Employees, and this type of plan provides individual IRA benefits to all eligible employees, similar to standard 401(k) plans.
- They are relatively easy to set up and have lower administrative fees in comparison to other retirement savings plans.
- Employees can make contributions to the plan through tax-deferred payroll deductions.
- In 2019, employees can contribute up to $13,000, and up to $16,000 for those 50 and older.
- Employers have the option to match employee contributions up to 3% of the employee’s compensation, dollar-for-dollar. If an employer chooses instead to make nonelective contributions of 2% of each eligible employee’s compensation, employer contribution matching is not mandated.
- Contribution limits are somewhat more limited than other options like the SEP IRA or a standard 401(k) plan.
- A 401(k) plan, or a defined contribution plan, is a retirement savings plan sponsored by an employer who allows participants the opportunity to defer a portion of their salary on a pre-tax basis and offers more flexibility than other retirement savings plans. Since the employer is also an employee, a 401(k) allows the employer to also set aside money for the future, tax-deferred.
- These plans provide higher contribution levels ($19,000 for people under 50 years of age and $25,000 if over 50 years of age).
- Employee and employer contributions cannot exceed 100% of any participant’s compensation up to $56,000 in 2019.
- An employer can make contributions to a 401(k) in the form of a matching contribution or a Profit Sharing Contribution, but employer contributions cannot exceed 25% of total eligible payroll.
- 401(k)s remain tax-deferred as they grow and are taxed upon retirement.
Solo 401(k) Plan
- To establish a Solo 401(k), a business must have no full-time employees other than the business owner and his or her spouse.
- The maximum contribution limit exceeds those of other tax-deferred retirement savings plans such as IRAs, but Solo 401(k) plans are still subject to the same contribution limit guidelines as all other 401(k) plans – a maximum of $19,000 for those up to age 50, and additional catch-up contributions of $6,000 for those over age 50.
- When you establish a Solo 401(k) plan, you can make contributions to your retirement savings as both the employee and employer. Your contributions as an employee cannot exceed $19,000.
- Contributing to multiple retirement savings plans is allowed by the IRS, but the contribution maximum is per individual, not per plan.
Defined Benefit Plan
- A defined benefit plan is a qualified retirement plan that guarantees employees a specific level of benefit at retirement (the benefit is defined, not the level of contributions to the plan).
- In 2019, a defined benefit plan can provide an annual benefit of up to $225,000 (or 100% of pay, if less).
- Your contributions may vary from year to year, depending on the performance of plan investments and other factors, and the services of an actuary are generally necessary to determine the annual contributions you must make in order to meet the defined benefit.
- These plans can be attractive to businesses that have a small group of highly compensated owners seeking to contribute as much as possible on a tax-deferred basis.
Profit Sharing Plan
- One additional way you can reward your employees is by setting up a profit sharing plan and sharing excess funds among your employees at the end of each fiscal year, at your discretion and according to business conditions.
- Profit Sharing Plans can be set up with a provision to make profit sharing contributions as a part of your employer-sponsored 401(k) plan, or as a separate plan.
- Profit sharing contributions are made solely by the employer to all eligible employees, and it is possible to set different allocation amounts across employee levels, typically based on a percentage of an employee’s salary.
- It is important to note that profit sharing payments are not bonuses. Rather, they are deposited into individual employee retirement accounts, separate from their 401(k)contributions.
- Contributions cannot exceed the lesser of: 100% of any participant’s compensation OR $56,000 in 2019.
- Contributions can be fully vested immediately or vest over time according to a pre-established vesting schedule.
At Wickham Financial & Insurance Services, our team can meet with you to discuss your specific situation, provide you with additional information on any of the plans mentioned above, and help you determine the best plan(s) for your business.
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