Retirement Plans For Small Business
The different types of retirement plans available to small business owners reflect the wide variety of businesses that exist in our country. As entrepreneurs, we are well-versed in how each business is unique, and our expertise lies in matching clients with the ideal plan.
Depending on income level and number of employees, a self-employed person can contribute to an IRA, Roth IRA, SIMPLE, SEP, 401(k), or Defined Benefit Plan. So how does a business owner know which one is right?
The correct plan depends on the age of the employer, the number of employees, the amount of funds available to invest in a retirement plan, and the level of income. Our decision matrix is below:
What does the employer want to achieve? Do they want to administer a plan and provide a true benefit to their employees, or do they really want to build their own assets and possibly receive tax deductions?
How many employees do they have? Company-sponsored retirement plans are an expense to the company for administration but also for employer contributions. Depending on the plan, this can create big expenses for the company.
How much do they have available to fund the plan? If we put together a plan with high contribution limits but they can’t fund it, then the plan won’t work.
How long will the business be in business? If they plan to sell soon, a long-term plan like a 401(k) may not be worth the effort.
What is the growth plan for the company? Solid retirement plans can help recruit solid employees.
What does their census look like? A detailed discussion about the questions above will lead us to the correct plan. We then take a census of the employees and fine-tune the design of the plan. The census includes demographic and salary data about the employee group, as well as pertinent information about the ownership of the company. Once this homework is done, we get to work on the design of the plan.
Here are scenarios that illustrate the benefits of the different types of plans:
Defined Benefit Plans can provide significant benefits to a 55+ business owner who makes a very high income and has no employees. An example is a consultant, or even a husband and wife team that run a very profitable business. A Defined Benefit Plan is a pension plan, so the contribution maximum depends on several factors, including age, income, and assets in the plan. The Defined Benefit Plan can allow substantial contributions, which result in substantial tax deductions. While the plan needs to be established in the year the income is earned, the contribution can be delayed to the following year.
The SEP Plan works well for a very small business with few employees. The employer can contribute up to $53,000 per year (2016 contribution data), but is also required to make contributions in proportion to the employees' salaries/wages. This means that everyone’s contribution is the same percentage of salary. That can get very expensive, depending on the number of employees. There are some options to exclude newer employees and employees who don’t work a minimum number of hours.
While 401(k) plans are suitable for employers with a large employee base, they are also flexible enough to provide great advantages to business owners with no employees at all, especially when paired with a Defined Benefit Plan.
The other end of the spectrum is a business owner with many employees and no desire to administer a retirement plan due to the time and expense associated with it. That owner may just opt to contribute to her own Traditional or Roth IRA.
As with all of our recommendations, tax consequences are a significant factor in our final design. We work with our clients’ tax professionals and a Third Party Administrator (TPA) for a comprehensive analysis of the final plan.
For more information regarding your retirement plan options, please email teamdbt@brennanfinancialservices.com.
This information is not intended to be a substitute for specific individualized investment planning advice as individual situations will vary. The information presented here should only be relied upon when coordinated with individual professional advice.