This article was updated on Oct. 23, 2018.
Employee retirement plans are a key component of any benefits package. Such a plan keeps your company competitive in the search for talented candidates and helps retain current employees. Employer-sponsored plans also offer some tax benefits, as contributions to employees' accounts can be a deductible business expense.
Depending on the size of your business, you have several plan options to consider. Here are the three basic types.
Through a Simplified Employee Pension (SEP) plan, employers set aside money in retirement accounts both for their employees and for themselves. This plan is available to businesses of any size and permits contributions of up to 25 percent of each employee's pay. Its structure is similar to a traditional individual retirement account (IRA): it is invested in the stock market, has a required minimum distribution at the age of 70.5 and the option for tax-free rollovers into another qualified plan. Employers don't need to file annual paperwork with the IRS, and employees are 100 percent vested in, or own, their funds.
The SIMPLE (Savings Incentive Match Plan for Employees) IRA plan is often favored by businesses with 100 or fewer employees. Business owners create the plan through a financial institution, which is responsible for its administration. To participate, employees must have earned a minimum of $5,000 in compensation in any two prior calendar years from their current employer, and be on track to earn at least the same amount in the current year. Employees can elect to make contributions from their salary, and employers are required to contribute to it every year. They have the option to alternate between the mandatory 2 percent nonelective contribution and a 3 percent matching contribution, as long as they adhere to IRS regulations.
In a 401(k) plan, employees contribute through pretax deductions from their paychecks, which employers can choose to match, within limits. The IRS sets inflation-indexed employee contribution limits that are reassessed annually. Depending on the type of plan, employees either select the investments they wish to fund or let the employer hire professionals to manage investments. These contributions are tax deductible in the year in which they are made, and earnings from the investments grow on a tax-deferred basis.
All 401(k) plans restrict the amount of money employees can withdraw from their funds and when. If employees take money before reaching the plan's designated retirement age, they may face tax penalties.
Variations on this plan include:
- A Roth 401(k) plan, which collects after-tax contributions.
- A 403(b) plan for nonprofit organizations such as hospitals and public school systems.
- A 457 plan for state and local government employees.
When choosing employee retirement plans that best match the needs of your small business, be sure to explore the tax advantages of each and opportunities to deduct contributions as a business expense. That way, you won't just be looking after your employees' future; you'll be helping your business's future, too.