401k Options For Small Business Owners

401k Options For Small Business Owners – Help small businesses choose the right retirement plans for their employees. CPAs can help business owners understand the various options available. By Jimmy J. Williams, CPA/PFS

Pension plans provide important tax benefits to small business owners and give them and their employees an incentive to save for the future. Several types of pension plans are available to small businesses, each with their own requirements and limitations. One plan isn’t necessarily right for companies of all sizes and ownership structures, so small business owners need to do their homework before making a decision.

401k Options For Small Business Owners

401k Options For Small Business Owners

As a CPA, you can help business owners choose and implement the plan that is best for them. You can base your recommendations on unique aspects of the client’s business, such as the owner’s retirement goals, how the business is set up (such as a sole proprietorship, limited liability company, C corporation, or S corporation), number of employees, and so on. You can also help them understand the legal and compliance issues associated with each type of plan, as well as any tax benefits it may provide.

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The following is an overview of the types of plans, and a discussion of issues to consider when helping small business owners through the often confusing process of choosing a retirement plan.

Different types of retirement plans are available to small business owners. The most important ones include the following (see the chart “Comparing Small Business Pension Plans,” for more information on the four most common plans):

SEPs can be used by businesses with any number of employees. Contributions are made only by the employer (up to the lesser of 25% of each eligible employee’s compensation or $55,000 in 2018) and are deductible as business expenses. The biggest advantage of SEP systems is how easy they are to manage. After adoption, no annual IRS returns are usually required for the SEP, and the administrative costs are minimal.

There are three steps to establishing an SEP. The employer must (1) enter into a written agreement to provide benefits to all eligible employees; (2) provide employees with specific information about the Agreement; and (3) set up an IRA account for each employee. The IRS has a model SEP program document, Form 5305-SEP, Simplified Employee Pension — Contribution Agreement for Individual Retirement Accounts. However, not all employers can use Form 5305-SEP, and some must use the model document instead.

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However, SEPs do not allow employees to defer income, and employees are always covered by employer contributions to their SEPs. Therefore, they may not be the best option for companies in industries with high employee turnover or who want to use a pension scheme to retain employees. Another potential disadvantage of these plans is that they require the employer to contribute the same percentage to all eligible employees. Because of this requirement, a small sole proprietorship may lack sufficient capital to support such a plan if the owner wishes to make a large contribution to his SEP.

Simple IRAs are generally available to businesses with 100 or fewer employees that received $5,000 or more in compensation in the previous year. These programs are financed through tax-deductible employer contributions and employee contributions before tax.

As the name implies, SIMPLE IRAs are easy to use and manage. To use this program, the employer can use Form 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – Not Used with a Designated Financial Institution, or Form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers. (EASY) — To be used with an established financial institution. Like Form 5305-SEP, the employer is required to keep the form in its records but not file it with the IRS.

401k Options For Small Business Owners

A small employer may want to use a SIMPLE IRA plan because it allows employees to defer income by making tax-deductible contributions (subject to annual limits) to their SIMPLE IRA. Another potential benefit to the employer of a SIMPLE IRA plan over a SEP is that it usually requires a smaller contribution from the employer. The employer must match each employee’s salary reduction contribution dollar for dollar up to 3% of the employee’s compensation or make a non-elective contribution of 2% of the eligible employee’s compensation (up to $275,000 in 2018), regardless of whether the employee pays salary reduction contributions.

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Like SEPs, however, SIMPLE IRAs are always 100% employee tax deductible, so they may not be the best choice for businesses in high-profit industries.

Qualified plans are more complex than SEPs or SIMPLE IRAs and therefore have stricter reporting requirements. But they may be more suitable for large or growing businesses. Larger businesses often have the staff and infrastructure to handle the reporting requirements of a qualified plan, and generally want features such as loan terms and operating withdrawals allowed in qualified plans that are not allowed in a SEP or SIMPLE IRA. There are several types of qualifying schemes, which can be divided into two broad categories: defined benefit and defined contribution schemes.

Defined benefit plans. Often referred to as pension plans, defined benefit plans promise to pay employees a steady income over a period of time in the future. The amount each employee receives is generally based on salary history and length of service. Employers must contribute enough to a defined benefit plan each year to satisfy what is known as the minimum funding requirement. Due to the complexity of the minimum amount and other requirements, the administration of a defined benefit plan often requires the professional help of an actuary. For that reason, very few small businesses use them.

Defined contribution plans. With defined contribution schemes, employers contribute to each employee’s individual accounts. Employees generally have the right to invest as they see fit within the investment options offered by the plan. Defined contribution schemes do not require immediate vesting of amounts contributed to the scheme from employers and may allow employee loans.

K Plans For Small Business Owners

Types of defined contribution plans include profit sharing plans and stock purchase plans. Under a profit-sharing plan, employer contributions are optional, so that the employer does not have to contribute to the plan every year. Under the money purchase plan, contributions are mandatory, so the employer must make a contribution to the plan each year, and the contribution percentage used to determine each year’s contribution amount cannot vary.

Profit-sharing plans may include a 401(k) feature (also known as a cash or deferred plan, or CODA) where employees participating in the plan may elect to have a portion of their pre-tax compensation contributed to each account instead of receiving it. compensation in cash. These contributions are called “elective deferrals” because the employee chooses to defer receiving the amount deposited into the account. A profit-sharing plan with 401(k) features is popularly known as a “401(k) plan.” A “solo 401(k) plan” is a 401(k) plan that includes only the business owner and his or her spouse.

For 2018, participants in a 401(k) plan can make special deferrals of up to $18,500 ($24,500 for participants age 50 or older at the end of the calendar year). If the plan allows, employers may contribute a percentage of each employee’s compensation to the employee’s account (non-discretionary contributions) or they may, within certain limits, match the amount of the employee’s discretionary deferral or both. Total employer and employee contributions to a 401(k) plan are limited to the lesser of:

401k Options For Small Business Owners

A 401(k) plan can be designed so that employee ownership of employer-matched or non-preferred funds vests over time, depending on the vesting plan. After the contribution period is over, the worker receives 100% of the money contributed by the employer and has the right to never lose the full contribution amount in his account. Making employer contributions to a pension plan can help an employer retain key employees.

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According to a standard contribution plan, the employee makes contributions to the employer continuously over a certain number of years. Most schemes use a five-year vesting plan, where the employee contributes 20% of employer contributions during the year of service, and the employee is vested with 100% of the funds at the start of the 6th year. For example, an employer’s plan document includes a five-year schedule for making employer matching contributions and nonselective contributions to employee accounts as a plan provision. The employer makes employer matching contributions to the employee’s retirement account in the amount of $10,000 in Year 1. If the employee decides to leave the company during his second year of service, he will be entitled to keep $2,000, or 20%, of the employer’s contributions.

Alternatively, some plans provide for “cliff vesting.” With clipped accrual, the employee earns all employer contributions subject to accrual after the employee has achieved a certain minimum number of years of accrual. This method of giving money reduces the amount of employer contributions retained by employees in their retirement pay

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