Saving for the Future
How Small Businesses Can Maximize Retirement Options
Hilary Ingoldsby Whitesides
November 1, 2008
It is an American dream: start your own business, be your own boss, make ends meet while giving others the same opportunity and one day retire to enjoy the fruits of your labor. But with recent national economic instability, including future social security predictions, having personal retirement plans becomes more crucial for working Americans, especially small business owners.
The Small Business Act of 1953 defines small business as “one that is in-dependently owned and operated and which is not dominant in its field of operation,” with employee and annual income regulations varying widely. The act also established the Small Business Administration (SBA) to help small businesses succeed amid larger firms by providing legal advice and protection, loans, including recovery loans in times of need and of course retirement options. According to the Department of Labor (DOL) an estimated one million businesses with 100 or fewer employees currently offer retirement plans for their employees.
According to the SBA, retirement plans fall under the umbrella of two types of plans: defined benefit or defined contribution. In a defined benefit plan, also known as a pension, the employer makes all the contributions and decides where to invest the money. The employer also promises to pay the employee a certain amount of their income after retirement. Defined contribution plans encompass a wide variety of plans that allow employees to choose where to invest their funds, employer contributions or matching, or a combination of the two. IRA based plans are also available to small businesses.
Darin Frandsen, a financial advisor for Edward Jones Investments in St. George, says SEP IRA’s and SIMPLE IRA’s are two of the most popular and feasible retirement plans for small business owners and their employees.
SEP IRA: Frandsen says this type of plan is ideal for business owners with no employees or fewer than 10 employees. A SEP IRA is available to employees age 21 and older, with the employer making the contributions. Contributions can vary from year to year with the maximum contribution being 25 percent of total income up to $46,000. “These are good for business owners because they can save up to $46,000 or 25 percent of their salary for themselves which is a lot higher than most other retirement plans,” Frandsen says.
SIMPLE IRA: “Generally, SIMPLE IRA’s are appropriate for businesses with fewer than 20 employees,” Frandsen says, “The plan is not available if there are more than 100 employees.” With a SIMPLE IRA employees make salary deferrals that are matched up to a certain percentage by their employer. There are no age requirements for SIMPLE IRA’s, but employees must have earned at least $5,000 annually in any two years and be expected to earn at least that much in the current year.
While SEP IRA’s and SIMPLE IRA’s are good options for many small businesses, they aren’t the only avenues available to small businesses.
401(k): A 401(k) is similar to a SIMPLE IRA with employees contributing through payroll deductions and employers contributing up to a certain percentage of the employee’s salary. According to the DOL, these plans are more complex, but allow for higher contribution limits and the option of profit-sharing contributions.
Safe Harbor: A Safe Harbor 401(k) is similar to a standard 401(k) except it requires a minimum contribution for employees. As the name denotes, Safe Harbor also provides safety for employers by relieving them of liability for investment results. Beginning this year, employers can also offer Automatic Enrollment Safe Harbor that automatically enrolls employees in the plan unless they opt out, thus, requiring less paper work for the employer.
Keeping an Edge
Aside from the benefit of future financial stability, retirement plans can help businesses hire and retain good employees. Also, offering a retirement plan keeps businesses more competitive in their industries. Employee contributions are deductible from the employer income and employee contributions, which grow tax free, are not taxed until distributed to the employee, according to the IRS. Additionally, there are tax credits available to smaller business owners, usually with fewer than 100 employees, for the cost of setting up certain plans.
One of the biggest concerns for many small business owners is the financial strain of starting and maintaining a retirement plan for employees.
“One thing I tell business owners is to consider the costs associated with employee turnover, and to evaluate if offering a retirement plan might give their employees incentives to stay with the company and, thus, reduce some of those costs,” Frandsen says. If you get it right, it will.