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September 2011
Choosing a Retirement Plan for Your Business
By Bucky W. Glover

     Business owners primarily use retirement plans to reward employees, save income taxes, and accumulate retirement funds for themselves. Offering a retirement plan provides a competitive advantage and improves the ability to attract and retain employees. Retirement plans offer valuable tax deductions and allow investment earnings to grow tax-deferred. Many options are available and selecting the right plan for your business can be a confusing process. Simplifying your choices can help make the decision more clear.

     Retirement plans can be broken into two broad categories: IRA-based plans and qualified retirement plans. IRA-based plans are typically more suitable for businesses with a small number of employees. Qualified retirement plans are regulated by the Employee Retirement Income Security Act (ERISA) and are more complex, but offer benefits not available in IRA-based plans. A few of the more common retirement plan options are listed below.

 

 

 

IRA-Based

Qualified

Retirement Plan

 

Employer-

Funded

 

SEP-IRA

(Simplified Employee Pension Plan)

 

Defined Benefit Plan

 

Profit Sharing Plan

 

 

Employer AND Employee

Funded

 

 

SIMPLE-IRA

 

Traditional 401(k)

 

ROTH 401(k) feature

 

 

IRA-Based Plans

     IRA-based plans are relatively inexpensive to maintain and are easy to start and administer. A summary of the features of IRA-based retirement plans follows.

 

 

 

SEP IRA

 

Simple IRA

Business Size

Any size – most frequently used by businesses with only a few employees

Any business with 100 or fewer employees

 

Employer Contributions

 

Discretionary – contribute equally for all eligible employees

 

Required minimum contributions

 

Employee Contributions

 

Not allowed

 

Optional

 

Vesting

 

Employee is always 100% vested in all SEP-IRA money

 

Employee is always 100% vested in all Simple-IRA money

 

Annual Filing Requirements

 

None

 

None

 

Contribution Limit for 2011

 

 

The lesser of 25% of compensation or $49,000

 

Up to $49,000

 

Employee Contribution Limit for 2011

(salary reduction contributions)

 

No employee contributions allowed

 

$11,500

$2,500 catch-up contributions for employees age 50 or older

 

Qualified Retirement Plans

     Qualified retirement plans provide options not available in IRA-based plans, and allow business owners choices in plan benefits. Commonly utilized choices allowed include participant loans and a vesting schedule for employer contributions. Also, under a qualified plan, business owners are often able to contribute more for themselves than would be available under an IRA-based plan.

     Two categories of qualified retirement plans exist: defined benefit plans and defined contribution plans, and specific types of plans are allowed under these categories. The use of defined benefit plans has declined in recent years due to the complexity and cost required to maintain these plans.

     Defined contribution plans are generally less complex and less expensive to administer than defined benefit plans. The employer bears no risk for paying a specified benefit at retirement, rather, the amount of the contribution into the plan is defined each year. The ultimate benefit to be received at retirement is limited to the amount in the employee’s account.

     Commonly utilized defined contribution plans include profit sharing and 401(k) plans. Both of these types of retirement plans are available to any size business and allow a business to have other retirement plansfrequently a profit sharing plan is used in combination with a 401(k) plan.

 

 

 

Profit Sharing Plans

401(k) Plans

All Types

Employer Contributions

Discretionary

Discretionary

 

Employee Contributions

 

Not Allowed

 

Optional

 

Individual Accounts

 

maintained for each participant

 

maintained for each participant

 

Vesting

 

Employees vest in employer contribution

 

Employees vest in employer contribution

 

Annual Filing Requirements

 

Form 5500

 

Form 5500

 

Contribution Limit for 2011

 

The lesser of 25% of compensation or $49,000

 

Up to $49,000

 

Employee Contribution Limit for 2011 (salary reduction contributions)

 

No employee contributions allowed

 

$16,500

$5,500 catch-up contributions for employees age 50 or older

 

     Plan discrimination testing is required in defined contribution plans because contributions can not unfairly benefit the owner or highly compensated employees. The testing is performed to make sure contributions and /or deferrals are not too highly weighted to senior management.

 

Consider one simple base line test before selecting a plan.

     Is the amount contributed to the plan that accrues to your employees equal to or less than the income tax savings generated by having the plan? Many businesses would rather pay their employees than pay income taxes. Consider the following example.

     A business is considering a $10,000 contribution to their retirement plan. The business’ combined federal and state tax bracket is 40%.

     The $10,000 deduction for the retirement plan contribution will reduce the business income tax by $4,000 ($10,000 x 40%).

      The $10,000 is allocated inside the plan to each eligible employee of the business including all owners/employees. If the amount allocated to the non-owner employees is equal to or less than $4,000, the owners are receiving the same or more wealth accumulation by having the plan as without the plan. The tax savings generated by the retirement plan contribution are used to benefit the employees.

 

Deciding What is Best for You

     Knowing a little bit more about the types of retirement plans available should make choosing a retirement plan more clear. Basically you need to prioritize your goals and find the plan that best meets your needs. Qualified plans are highly regulated but offer features not available in IRA based plans. The retirement saving opportunities provided by qualified plans usually justify the cost and administrative expenses. There are many retirement plan choices available to you as a business owner, so after evaluating your retirement goals choose the plan that suits your retirement plan needs and objectives.

     Content contributed by Potter & Company, a locally based certified public accounting firm offering core services of professional accounting, business consulting, and financial analysis. For more information, contact Bucky Glover at 704-283-8189 or visit www.gotopotter.com.

 

CPA, CVA and Partner at Potter & Company.
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