The ABCs of Retirement Plans
They're boring, confusing--and yet key to your future. Here, we make sense of the retirement mumbo jumbo
There's a reason so many business owners hate thinking about retirement plans: they're about as much fun as root-canal work--but more expensive and more complicated.
Still, with several new types of plans available to small businesses this year, it pays to know your options. Here's our guide through the acronym jungle:
SIMPLE IRAs. Remember IRAs (individual retirement accounts)? Now Congress has created new SIMPLE IRAs specifically for small businesses to offer as an employee benefit.
How do they work? Like ordinary IRAs, SIMPLE IRAs allow participants to accumulate tax-deferred retirement savings. The main differences: if your company offers a SIMPLE IRA, employees can contribute up to $6,000 of their income annually, compared with $2,000 with ordinary IRAs. You don't have to administer SIMPLE IRAs but must make employer contributions through one of two different methods of calculation. (Did anyone really believe these were going to be simple?) Only companies with 100 or fewer employees can qualify for SIMPLE IRAs.
Hassles? Thanks to a newly released IRS form, 5305-SIMPLE, setting up these plans should be nearly as painless as starting a regular IRA; you can call a bank, a mutual fund, or a brokerage house. But those matching calculations could be a pain.
Benefits? For you, a $6,000 annual limit is better than the $2,000 you could add to an ordinary IRA. For employees, there's the added plus of employer matching.
Costs? Those matching costs will add up. In addition, expect an annual custodial fee that will range from $10 to $30 per participant, estimates retirement-plan consultant Daniel E. Maul.
401(k) Plans. These are the plans every business owner loves to hate--even the people who know next to nothing about retirement planning. They're an easy target, since they are certainly more complicated and expensive than any IRA. However, 401(k)s offer more options than IRAs do and allow participants to achieve greater retirement and tax savings. That should be music to the ears of many of your key employees, as well as to you.
How do they work? With difficulty, sometimes. This year employees can contribute up to $9,500 or 15% of their salary, whichever is lowest. That's the easy part. The difficulty arises from nondiscrimination rules, which prevent workers defined as "highly compensated" from contributing much more than the average percentage contribution of non-highly-compensated workers. Already overwhelmed? Then we'll leave it to your lawyer or accountant to explain the pros and cons of complying with voluntary 404(c) guidelines, which may help protect your legal hide.
Hassles? Setting up a 401(k) is not so bad if you choose a readily available prototype; it's complex if you decide to get fancy and fine-tune a plan of your own. In either case, running the 401(k) is complicated. Hiring a plan administrator will reduce headaches but increase costs.
Benefits? Plenty: high contribution limits, plus lots of flexibility about if and how you match employee contributions. Plus, 401(k)s are attractive to employees, too--especially if you do decide to match.
Costs? For a prototype plan administered by an outsider, Maul says you can expect to pay up to $1,000, plus $20 to $30 per participant per year; that includes plan documentation, discrimination testing, and administration.
SIMPLE 401(k) Plans. Sound familiar? Congress created these along with SIMPLE IRAs. Why choose this kind of plan instead? A lot of entrepreneurs are going to be asking exactly that question. One plus: as with regular 401(k)s, these will permit participants to borrow funds.
How do they work? Kind of like regular 401(k)s--but not really. The similarities: employee contributions go into a pool of retirement savings that must be administered by either the company or a third-party administrator. The differences: participants can contribute only up to $6,000 of their salaries annually, and employers must offer matching. (Remember those two matching methods from SIMPLE IRAs? You've got the same ones here.) Only companies with 100 or fewer employees need apply.
Hassles? It's hard to say for sure, since these plans are new. However, you'll probably be OK if you stick to a predeveloped prototype plan from a reputable financial adviser. In the end, SIMPLE 401(k) plans should be less hassle to administer than regular 401(k)s, or so it's hoped. The big advantage is freedom from nondiscrimination tests.
Benefits? For you, that $6,000 limit is still appealing, but you do have to match what workers put in. For employees, the trade-off for a lower contribution limit is mandatory employer matching. Staffers won't complain.
Costs? These plans should be less costly to administer than regular 401(k)s, but then there's the mandatory matching.
Simplified Employee Pension Plans (SEPs). Skip this option if you care about including a salary-reduction feature in your company's retirement-savings plan: these plans get funded by the company only. So why bother? One big reason is that you don't have to persuade a lot of lower-level employees to sign up, the way you must with 401(k) plans, in order to fully fund your top people. The downside: you do have to pay for all the employees, and that can make these plans quite costly. (Until this year you could instead form a SARSEP, a similar plan that included a salary-reduction component; however, Congress has changed the rules, and no new SARSEPs can be formed.)
How do they work? Pretty easily, which is why SEPs are nicknamed the "business IRAs." Basically, you set up a plan with an account in each employee's name and then contribute the same percentage of salary to each account. The good news: contribution levels are flexible and can be adjusted within plan limits each year, as long as you don't try to discriminate among employees.
Hassles? SEPs are comparatively easy to set up: follow IRS Model Form 5305-SEP. The ongoing paperwork is also not bad. As with other plans, you may want to hire an investment professional to advise employees on investment choices.
Benefits? Thanks to high contribution levels (up to 15% of salary or $30,000), owners and executives can often sock away more than they can with a 401(k) plan. You can also adjust levels downward (or skip contributions entirely) during slow years. But ouch! Those contributions to all employees might hurt. But for employees, this one is almost too good to be true, since the employer picks up all the costs.
Costs? These are cheapies to administer, but the cost of funding the plan--especially at higher levels--will add up.
Before You Choose
Here are some key issues that experts advise business owners to address when setting up retirement plans.
- Who within the company actually wants a plan? "It's very useful to survey your employees before making any decisions, because you may find that not enough of them care about this benefit to justify the expenses and administrative headaches," notes John A. Cutler, a partner at Beers & Cutler, an accounting firm based in Washington, D.C.
- What can you afford to spend? Nick Constantinesco, a certified public accountant with Virtual Growth Inc., in New York City, believes that the expense of the plans generally can't be justified by growing companies that haven't reached profitability. "It just doesn't make sense for a business owner to put retirement savings--his or his employees'--ahead of the company's growth," he observes. Cutler points out two possible exceptions: "When profitability is ensured within the next year or so--or you've just got to have a plan to attract the highly skilled staffers you need."
If you can't afford a company plan yet, don't give up. In the meantime, consider setting up a personal IRA for retirement savings. Check with your accountant about recent IRA rule changes./li>
- Where should you invest your (and your employees') retirement savings? "Don't let yourself get bogged down with this question," urges Daniel E. Maul, president of Retirement Planning Associates, a consulting and investment-advisory firm in Kirkland, Wash. "You'll have millions of investment options. The thing to decide first is which type of plan is right for you."
- When should you consider moving beyond the basic plans described here? If your company is consistently profitable, successful, and stable, you may want to consider adding a customized retirement plan, such as a profit-sharing or a defined-benefit plan. Customized plans, designed especially to fit your company's needs by a legal or accounting retirement-plan specialist, offer the potential for extra savings by owners and selected employees.
Jill Andresky Fraser is Inc. 's finance editor.
There's nothing simple about the world of retirement planning at the moment: even finding a good, comprehensive resource is complicated. That's because the best guides became outmoded on January 1, when SIMPLE plans were launched and SARSEPs closed down for anyone who didn't already have a SARSEP in place. Government delays in finalizing paperwork and other requirements should slow down the publication of new and revised editions. So you may have to wait.
In the meantime, if you have or plan to start a 401(k) plan, check out the 401k Provider Directory Small Plan Guide (HR Investment Consultants, 800-462-0628), designed to help business owners whose plans cover 150 or fewer participants. It's a comprehensive comparison-shopping guide that details the fees and services of 45 large mutual funds, insurers, banks, and other 401(k) providers. Although it's a tad pricey at $85, it more than makes up for its cost in potential savings.
BEERS & CUTLER, John Cutler, 1250 Connecticut Ave. NW, Fourth Floor, Washington, DC 20036; 202-331-0300; firstname.lastname@example.org 103
RETIREMENT PLANNING ASSOCIATES, Daniel E. Maul, 720 Market St., Suite G, Kirkland, WA 98033; 800-546-5406; email@example.com 103