One advantage is that contributions to a retirement plan today can help you meet tomorrow’s goals of financial security. Another is that establishing a retirement plan may provide tax advantages. Eligible contributions are deductible expenses to your business, and all contributions grow tax-deferred until withdrawn*. Still another benefit is that it can create positive employee relations, helping to attract and retain quality employees, while reducing turnover.
For many business owners, the question is not “Should I implement a retirement plan?” Rather, it is “Which plan is right for my business?” The choices are many: SEP, profit sharing, 401(k), SIMPLE IRA, and defined benefit, to name a few.
This information is designed to help resolve some of the confusion caused by the wide range of choices available to business owners. It offers an overview of the features and advantages of the different types of plans, as well as a chart that provides a more detailed look at the specific characteristics of:
• Simplified Employee Pension (SEP)
• SIMPLE IRA
• Profit sharing
• Age-weighted/comparability profit sharing plans
• 401(k) profit sharing
• Safe Harbor 401(k)
• Owner-only/one-person 401(k)
Before examining your available choices, let’s consider some basic facts about the different types of retirement plans. Two general categories are available: defined contribution plans and defined benefit plans. Defined contribution plans, as the name implies, define the contributions to be made each year the plan is in operation. An allocation formula specifies a percentage of compensation to be contributed on behalf of each of the
participants. The monies grow tax-deferred until withdrawn from the plan. Defined benefit plans, on the other hand, define the benefits to be received at retirement. We will ignore these as they are generally not practical for a small business owner.
The plans listed in this article are considered defined contribution plans. All, except SEP, SIMPLE, and Safe Harbor 401(k) plans, allow employer contributions to be subject to a vesting schedule that requires a certain number of years of service to become fully vested.
Most employer-sponsored retirement plans are required to file a Form 5500 with the IRS, which discloses specific plan activities during the year. The preparation and filing of this annual report adds to the administrative expense of maintaining the plan. Your tax advisor can provide more specific information on this process, or your Raymond James financial advisor can assist you in finding a plan administration professional.
Employee withdrawals from a retirement plan made before the age of 591/2 or normal retirement age may be subject to a 10% IRS penalty for early withdrawal, in addition to being subject to ordinary income tax. Additional brochures that address plan distribution issues are available upon request.
Time Is On Your Side
Consider the savings habits of this 20-year old couple. The wife starts putting $2,000 per year into a tax-deferred investment when she is 20. After 10 years, she decides to stop investing and just let her money grow until she retires. The husband decides to start investing when his wife stops. He invests $2,000 a year in a tax-deferred investment from the time he is 30 until he retires at age 65. If they both earn 8% on their savings, who will have more money at age 65?
Time and compound interest favor the wife. She will have $462,648 at age 65, while her husband will only have $372,204.
Use time to your advantage -- start saving early!
Key Points to Look for in Retirement Planning Advisors
Investment Flexibility
The firm that you choose should not have only a proprietary fund package on top of its list of retirement plan alternatives and services. Their advisors should be able to utilize any of the top providers in the retirement plan market. This allows them to maintain a more consultative approach to help clients select the package that best fits the needs of their businesses. In addition, they should work with many professional plan administration firms within the industry, so they can help provide solutions to more complex plan designs or compliance needs that may arise with a customized plan.
Prototype Plans
The firm should offer the small business a variety of retirement plan options, including prototype plans that are easy to adopt and maintain. As an example, investment firms currently offer profit sharing and 401(k) profit sharing prototype plans. Many provide automatic updates of prototype plans, making it relatively simple and inexpensive to keep your plan up-to-date with any tax law changes.
Asset Protection
The firm providing the retirement plan solution should also have adequate insurance coverage. For example, each account custodied by Raymond James & Associates is protected for the net equity of the client’s securities and cash positions. This firm is a member of the Securities Investor Protection Corporation (SIPC), which protects securities customers of its members up to $500,000 of net equity, including $100,000 for claims for cash awaiting reinvestment. You can visit sipc.org for more information about SIPC coverage. Account protection applies when a SIPC-member firm fails financially and is unable to meet obligations to securities clients, but it does not protect against market fluctuations.
Professional Service
The financial advisors that you select should have the training and expertise to assist you in choosing the retirement plan for your business and the investment strategies for your plan. This is a complex and ever- changing area that requires close coordination of investment, tax, and legal advisors. An experienced professional in each of these areas is critical to success.
General Rules
After reading this information, you should better understand the general rules of retirement plans. The following summary is designed to help you in clarifying these ideas relative to the plan selection.
• For employers with a long-time horizon to fund a plan for their employees, defined contribution plans work well.
• For sole proprietors or small business owners wishing to minimize administrative costs, a SEP or SIMPLE may be the best choice.
• For small business owners without employees wishing to maximize contributions, a one-person 401(k) may be the right plan.
• Profit sharing is appropriate if discretionary contributions or a vesting schedule are important.
• For employers with older key employees, defined benefit or age-weighted plans may be more appropriate.
• For employers who wish to have their employees fund a portion of the retirement cost, a SIMPLE or 401(k) plan may be most suitable.
Conclusion
What is the right retirement plan for your business? The retirement plans discussed here illustrate that there is a wide variety of choices available to you as a business owner. With help from your financial advisor – a professional committed to your needs – you can choose the plan that best suits your business retirement plan needs and objectives. Of course, we cannot offer legal advice to clients. Before implementing any plan, you should consult with your tax and/or legal advisors.