When, in 1999, spouses Jack and Jodi Raudenbush started their civil engineering firm, they wanted to offer workers a retirement plan. At first, they went for a "simple" IRA, which is easy to administer but restrictive about contributions. As Raudenbush Engineering ramped up hiring, the founders started hitting their plan's contribution limits ($12,500 in 2016 for workers under the age of 50). So eventually, the Raudenbushes switched to a costlier and more complicated 401(k) plan, which lets everyone save more (up to $18,000 per year for those under 50). Jack Raudenbush, vice president of the $4.6 million company, which is based in Middletown, Pennsylvania, estimates that the change costs a few thousand dollars per year but calls it money well spent: "This was the type of plan our competitors had, and we needed to offer competitive benefits." As financial planner Lawrence DeFluri, co-founder of SevenBridge Financial Group, says: "It's a tradeoff. And, as the business owner, you have to realize the plan you choose affects your personal situation, too."
1. As your company grows, choices shrink.
Once a for-profit business has more than 10 or 15 workers, the best retirement-plan options are likely to boil down to two: the simple (savings investment match plan for employees) IRA and the 401(k). Both give you the ability to contribute to your own retirement and provide attractive benefits for employees. The more highly paid workers you have, the more the 401(k) makes sense--though it also requires some truly epic paperwork.
2. Pass the discrimination test.
Fewer than half of Raudenbush's 40 employees contribute the maximum amount to the plan. If you employ more lower-wage and part-time workers, who may not be able to save as much, the simple IRA is the best choice, says Bruce Elliott of the Society for Human Resource Management in Alexandria, Virginia.
What makes the 401(k) so complicated is something called "discrimination testing," which consists of federal rules designed to ensure the company isn't giving better retirement benefits to its most highly paid workers, including executives and founders. Since the government gives companies and employees tax breaks for sponsoring and contributing to retirement plans, it wants to know that those breaks are being distributed fairly across all levels of pay. So if you want to offer a 401(k), be ready to file detailed, voluminous 5500 forms with the Department of Labor--and to do a lot of math. If your calculations find that your low-paid workers contribute a small percentage of their wages to the 401(k), higher-paid workers will face additional constraints on how much they can contribute. Worse, if your plan fails a discrimination test late in the year, it might have to kick back a portion of participant contributions at year-end. That would increase your workers' taxable income and your own--potentially wreaking havoc with taxes.
3. High cost, high reward.
There's also a "safe-harbor" provision that allows your 401(k) to avoid the discrimination tests. The catch is that your company must contribute at least 3 percent of pay to all participant accounts, regardless of whether the employee contributes. But 401(k) plans also have a flexible design that may allow you to tap retirement savings through plan loans-- for example, when you need to pay for college or want to buy a home. Those are benefits that can take care of the financial future both for you and for your employees.