Retirement Plans for Family Businesses
If your family business is a small to medium sized firm, you already know that providing competitive benefits can be a daunting proposition. Or so you thought. The truth is more than one million small businesses with 100 or fewer employees already offer workplace retirement savings plans – and offering retirement plans to your employees offers several advantages to your family business, not only to your employees. A retirement plan can have significant tax advantages:
- Your contributions are deductible when made
- Your contributions aren't taxed to an employee until distributed from the plan
- Money in the retirement program grows tax deferred (or, in the case of Roth accounts, potentially tax free)
Plans like Simplified Employee Plans (SEP) and SIMPLE IRAs are IRA-based plans. With these plans, your employees are vested in your contributions immediately.
Most employers can easily establish this low-cost retirement plan option. You can set up a SEP-IRA for yourself and your eligible employees. You contribute a specified percentage of pay for each employee, but you have flexibility in whether you make those contributions every year, which is helpful in times that are financially challenging for your business. For 2012, your contributions for each employee can be up to 25% of pay or $50,000, whichever is less. The plan must cover any employee aged 21 or older who has worked for you for three of the last five years and who has earned $450 or more in the current year.
- SIMPLE IRAs
This plan is available to employers with 100 or fewer employees, and it is also easy to set up and affordable to administer. Your employees elect to make pretax contributions of up to $11,500 for 2012 ($14,000 for those aged 50 or older). You must either match your employees’ contributions to 3% or make a fixed contribution of 2% of compensation for each eligible employee. Your 3% match can be reduced to 1% in any two of five years. To qualify, your employees must earn at least $5,000 in any two prior years and expect to earn at least $5,000 in the current year.
Retirement plans such as 401(k) plans, profit sharing plans and defined benefit plans are called qualified plans. These kinds of plans are more complicated and expensive to maintain because they must comply with specific Internal Revenue Code and Employee Retirement Income Security Act of 1974 (ERISA) requirements in order to qualify for tax benefits. Qualified plan assets are held in either in trust or by an insurance company. With qualified plans, you can require that your employees work a certain number of years before they vest in your contributions.
- 401(k) Plans
This qualified profit-sharing plan is a very popular choice. These plans give employees the ability to make pretax and/or Roth contributions of up to $17,000 for 2012. Contributions grow tax free until they are distributed. Combined contributions (yours and your employees’) cannot exceed the lesser of $50,000 or 100% of the employee’s pay for 2012. Additional catch-up contributions of $5,500 are allowed for employees aged 50 or older. You can make contributions by matching employee contributions or as discretionary profit-sharing contributions, typically to employees who have worked for you for one year or more – or you can allow them to contribute after two years if your contributions are immediately vested. With these plans, you are required to perform discrimination testing each year to ensure benefits aren’t disproportionately weighted toward higher paid employees.
- Safe Harbor 401(k) Plans
This variation of a 401(k) plans allows you to match your employees’ contributions (100% of employee deferrals up to 3% of compensation and 50% of deferrals between 3 and 5% of compensation) or make fixed contributions of 3% of compensation for all eligible employees, even if they don’t themselves contribute. Your contributions become fully vested immediately. These plans are not subject to discrimination testing.
- SIMPLE 401(k) Plans
Similar to SIMPLE IRAs, these plans also allow loans and Roth contributions. The tradeoffs are that these plans are more complicated than SIMPLE IRAs because they are qualified plans, and they allow less deferrals than traditional 401(k)s.
In this kind of plan, only you, not your employees, contribute – and these contributions are discretionary in terms of how much or whether to contribute each year. However, your contributions must be “substantial and recurring” for your plan to remain qualified. Your contributions must be based on a formula for how they are allocated among plan participants. For profit sharing plans, you can require a year of service before employees become eligible, or you can make employees eligible after two years of service if those contributions immediately vest.
Defined Benefit Plans
As the name suggests, this plan guarantees your employees a specified level of benefits at retirement, rather than a specific level of contributions. For example, you can establish an annual benefit equal to 30% of the employee’s final average pay. A defined benefit plan can provide an annual benefit of up to $200,000 or 100% of pay, whichever is less. To establish a defined benefit plan, you should work with an actuary to determine the annual contributions you should make in order to provide the promised benefit. These plans have the potential to provide the greatest benefit to your employees, and because your contributions are greater, you also have a larger tax deduction as a result.
Making Your Choice
Which kind of retirement plan is right for your family business depends on a variety of factors:
- How you want to save for your own retirement
- Whether you want to provide contributions to your employees
- The kind of flexibility you have with those contributions)
- The importance of pretax and/or Roth contributions
- The costs and ease of administration. Working with your retirement professional in answering these questions can help you decide which kind of plan is best for you and your family business.
Contributing Sources: http://www.sepira.com/faqs.html; www.irs.gov/retirement/participant/article/0,,id=211345,00.html;