Starting a retirement savings plan can be easier than most business owners think. What’s more, there are a number of retirement programs that provide tax advantages to both employers and employees.
Experts estimate that Americans will need 70 to 90 percent of their preretirement income to maintain their current standard of living when they stop working. So now is the time to look into retirement plan programs. As an employer, you have an important role to play in helping America’s workers save. By starting a retirement savings plan, you will help your employees save for the future. Retirement plans may also help you attract and retain qualified employees, and they offer tax savings to your business. You will help secure your own retirement as well. You can establish a plan even if you are self-employed.
Any Tax Advantages?
A retirement plan has significant tax advantages: Employer contributions are deductible from the employer’s income, employee contributions (other than Roth contributions) are not taxed until distributed to the employee, and money in the plan grows tax-free.
Any Other Incentives?
In addition to helping your business, your employees and yourself, it is easy to establish a retirement plan, and there are additional reasons for doing so:
High contribution limits so your employees (and you) can set aside large amounts for retirement; “Catch-up” rules that allow employees aged 50 and over to set aside additional contributions. The amount varies, depending on the type of plan; Tax credit for small employers that would enable them to claim a tax credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE, or certain other types of plans. The credit equals 50 percent of the cost to set up and administer the plan, up to a maximum of $500 per year for each of the first 3 years of the plan; Tax credit for certain low-and moderate-income individuals (including self-employed) who make contributions to their plans (“Saver’s Credit”). The amount of the credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent,depending on the participant’s adjusted gross income; and A Roth 401(k) program that can be added to a 401(k) plan to allow participants to make aftertax contributions into separate accounts, providing an additional way to save for retirement.
Distributions upon death or disability or after age 59½ from Roth accounts held for 5 years, including earnings, are generally tax-free.
Payroll Deduction IRAs
Even if an employer does not want to adopt a retirement plan, it can allow its employees to contribute to an IRA through payroll deductions, providing a simple and direct way for employees to save. The decision about whether to contribute, and when and how much to contribute to the IRA (up to $5,000 in 2011, $6,000 if age 50 or older, increasing thereafter) is always made by the employee in this type of arrangement.
Many individuals eligible to contribute to an IRA do not. One reason is that some individuals wait until the end of the year to set aside the money and then find that they do not have sufficient funds to do so. Payroll deductions allow individuals to plan ahead and save smaller amounts each pay period. Payroll deduction contributions are tax-deductible by an individual, to the same extent as other IRA contributions.
Simplified Employee Pensions (SEPs)
A SEP allows employers to set up a type of IRA for themselves and each of their employees. Employers must contribute a uniform percentage of pay for each employee, although they do not have to make contributions every year. Employer contributions are limited to the lesser of 25 percent of pay or $49,000 in 2011. (Note: the dollar amount is indexed for inflation and may increase.) Most employers, including those who are self-employed, can establish a SEP. SEPs have low start-up and operating costs and can be established using a two-page form. And you can decide how much to put into a SEP each year– offering you some flexibility when business conditions vary.
SIMPLE IRA Plans
This savings option is for employers with 100 or fewer employees and involves a type of IRA. A SIMPLE IRA plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. Under SIMPLE IRA plans, employees can set aside up to $11,500 in 2011 $14,000 if age 50 or older, by payroll deduction. For years after 2011, annual cost-of-living updates can be found at www.irs.gov/ep. Employers must either match employee contributions dollar-for-dollar – up to 3 percent of an employee’s compensation – or make a fixed contribution of 2 percent of compensation for all eligible employees.
If the plan provides for it, employers can choose to automatically enroll employees in SIMPLE IRA plans as long as the employees are allowed to choose not to have salary reduction contributions made to their SIMPLE IRAs or to have salary reduction contributions made in a different amount. SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs (to hold contributions made under the SIMPLE IRA plan) are set up for each employee. A financial institution can do much of the paperwork. Additionally, administrative costs are low. Employers may either have employees set up their own SIMPLE IRAs at a financial institution of their choice or have all SIMPLE IRAs maintained at one financial institution chosen by the employer. Employees can decide how and where the money will be invested, and keep their SIMPLE IRAs even when they change jobs.
401(k) plans have become a widely accepted retirement savings vehicle for small businesses. Today, an estimated 60 million American workers have employer-based 401(k) plans that have total assets of about $2.8 trillion. With a 401(k) plan, employees can choose to defer a portion of their salary. So instead of receiving that amount in their paycheck today, the employees can contribute the amount into a 401(k) plan sponsored by their employer. These deferrals are accounted separately for each employee. Deferrals are made on a pretax basis but if the plan allows, they can be made on an after-tax (Roth) basis at the employee’s choosing. Many 401(k) plans provide for employer matching or other contributions. Employer contributions and pretax deferrals (plus earnings) are not taxed by the Federal Government or by most state governments until distributed.
There are a number of types of 401(k) plans: a traditional 401(k) plan, a safe harbor 401(k) plan, or an automatic enrollment 401(k) plan. In all of these plans, participants can make contributions through salary deductions. A safe harbor 401(k) plan is intended to encourage plan participation among rankand-file employees and to ease administrative burden by eliminating the tests ordinarily applied under a traditional 401(k) plan. Automatic enrollment 401(k) plans can increase plan participation among rank-and-file employees and make it more likely the plan will pass the tests ordinarily required under a traditional 401(k) plan.
For More Information
The U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) enforces and administers the Employee Retirement Income Security Act of 1974 (ERISA). For publications, an interactive website, a video and more on the topics addressed in this article, visits EBSA’s website at www.dol.gov/ebsa. EBSA also provides information that will assist employers and employee benefit plan officials in understanding and complying with the requirements of ERISA as it applies to the administration of employee retirement, health and other welfare benefit plans as well as information for your employees about the importance of saving for retirement. Please visit EBSA’s website at www.dol.gov/ebsa for more information. If you have questions, contact us electronically at www.askebsa.dol.gov or by calling toll-free at 1.866.444.3272.