Retirement Plans for Small Businesses

If you're self-employed or own a small business
and you haven't established a retirement
savings plan, what are you waiting for? A retirement
plan can help you and your employees
save for the future. And you'll be in good
company--over 1 million small businesses
with 100 or fewer employees currently offer
workplace retirement savings plans.
Tax Advantages
A retirement plan can have significant tax advantages:
• Your contributions are deductible when made
• Your contributions aren't taxed to an employee until distributed
from the plan
• Money in the retirement program grows tax deferred (or,
in the case of Roth accounts, potentially tax free)
• You may be able to claim a tax credit equal to 50% of the
cost to set up and administer a retirement plan, up to a
maximum of $500 per year for each of the first three years
of the plan
• Certain low- and moderate-income employees may be
entitled to a tax credit ("saver's tax credit") for a portion of
their contributions to the plan
Types of Plans
Retirement plans are usually either IRA-based (like SEPs and
SIMPLE IRAs) or "qualified" (like 401(k)s, profit-sharing plans,
and defined benefit plans). Qualified plans are generally more
complicated and expensive to maintain than IRA-based plans
because they have to comply with specific Internal Revenue
Code and ERISA (the Employee Retirement Income Security
Act of 1974) requirements in order to qualify for their tax benefits.
Also, qualified plan assets must be held either in trust or
by an insurance company. With IRA-based plans, your employees
own (i.e., "vest" in) your contributions immediately.
With qualified plans, you can generally require that your employees
work a certain numbers of years before they vest.
Which plan is right for your business?
With a dizzying array of retirement plans to choose from, each
with unique advantages and disadvantages, you'll need to
clearly define your goals before attempting to choose a plan.
For example, do you want:
• To maximize the amount you can save for your own
• A plan funded by employer contributions? By employee
contributions? Both?
• A plan that allows you and your employees to make
pretax and/or Roth contributions?
• The flexibility to skip employer contributions in some
• A plan with the lowest cost? Easiest administration?
The answers to these questions can help guide you and your
retirement professional to the plan (or combination of plans)
most appropriate for you.
Simplified employee pension (SEP) plan
A SEP allows you to set up an IRA (a "SEP-IRA") for yourself
and each of your eligible employees. You contribute a uniform
percentage of pay for each employee, although you don't have
to make contributions every year, offering you some flexibility
when business conditions vary. For 2009, your contributions
for each employee are limited to the lesser of 25% of pay or
$49,000. Most employers, including those who are selfemployed,
can establish a SEP.
SEPs have low start-up and operating costs and can be established
using an easy two-page form. The plan must cover any
employee aged 21 or older who has worked for you for three
of the last five years and who earns $550 or more.
The SIMPLE IRA plan is available if you have 100 or fewer
employees. Employees can elect to make pretax contributions
in 2009 of up to $11,500 of pay ($14,000 if age 50 or older).
You must either match your employees' contributions dollar for
dollar--up to 3% of each employee's compensation--or make a
fixed contribution of 2% of compensation for each eligible employee.
(The 3% match can be reduced to 1% in any two of
five years.) Each employee who earned $5,000 or more in any
two prior years, and who is expected to earn at least $5,000 in
the current year, must be allowed to participate in the plan.
SIMPLE IRA plans are easy to set up. You fill out a short form
to establish a plan and ensure that SIMPLE IRAs are set up for each employee.
A financial institution can do much of the paperwork. Additionally,
administrative costs are low.
Profit-sharing plan
Typically, only you, not your employees, contribute to a qualified
profit-sharing plan. Your contributions are discretionary--
there's usually no set amount you need to contribute each
year, and you have the flexibility to contribute nothing at all in
a given year if you so choose (although your contributions
must be "substantial and recurring" for your plan to remain
qualified). The plan must contain a formula for determining
how your contributions are allocated among plan participants.
A separate account is established for each participant that
holds your contributions and any investment gains or losses.
Generally, each employee with a year of service is eligible to
participate (although you can require two years of service if
your contributions are immediately vested).
401(k) plan
The 401(k) plan (technically, a qualified profit-sharing plan with
a cash or deferred feature) has become a hugely popular retirement
savings vehicle for small businesses. According to the
Department of Labor, an estimated 48 million
American workers are enrolled in 401
(k) plans with total assets of about 2.4 trillion
dollars. With a 401(k) plan, employees
can make pretax contributions in 2009 of
up to $16,500 of pay ($22,000 if age 50 or
older). These deferrals go into a separate
account for each employee and aren't
taxed until distributed. Generally, each
employee with a year of service must be
allowed to contribute to the plan.
You can also make employer contributions to your 401(k)
plan--either matching contributions or discretionary profitsharing
contributions. Combined employer and employee contributions
for any employee in 2009 can't exceed the lesser of
$49,000 (plus catch-up contributions of up to $5,500 if your
employee is age 50 or older) or 100% of the employee's compensation.
In general, each employee with a year of service is
eligible to receive employer contributions, but you can require
two years of service if your contributions are immediately
401(k) plans are required to perform somewhat complicated
testing each year to make sure benefits aren't disproportionately
weighted toward higher paid employees. However, you
don't have to perform discrimination testing if you adopt a "safe
harbor" 401(k) plan. With a safe harbor 401(k) plan, you generally
have to either match your employees' contributions
(100% of employee deferrals up to 3% of compensation, and
50% of deferrals between 3 and 5% of compensation), or
make a fixed contribution of 3% of compensation for all eligible
employees, regardless of whether they contribute to the plan.
Your contributions must be fully vested.
Another way to avoid discrimination testing is by adopting a
SIMPLE 401(k) plan. These plans are similar to SIMPLE IRAs,
but can also allow loans and Roth contributions. Because
they're still qualified plans (and therefore more complicated
than SIMPLE IRAs), and allow less deferrals than traditional
401(k)s, SIMPLE 401(k)s haven't become a popular option.
Defined benefit plan
A defined benefit plan is a qualified retirement plan that guarantees
your employees a specified level of benefits at retirement
(for example, an annual benefit equal to 30% of final
average pay). As the name suggests, it's the retirement benefit
that's defined, not the level of contributions to the plan. In
2009, a defined benefit plan can provide an annual benefit of
up to $195,000 (or 100% of pay if less). The services of an
actuary are generally needed to determine the annual contributions
that you must make to the plan to fund the promised
benefit. Your contributions may vary from year to year, depending
on the performance of plan investments and other
In general, defined benefit plans are too costly and too complex
for most small businesses. However, because they can
provide the largest benefit of any retirement plan, and therefore
allow the largest deductible employer contribution, defined
benefit plans can be attractive to businesses that have a small
group of highly compensated owners who are seeking to contribute
as much money as possible on a tax-deferred basis.
As an employer, you have an important role to play in helping
America's workers save. Now is the time to look into retirement
plan programs for you and your employees.
Pathway Financial Services, Inc.
"Our mission is to help our clients realize their financial goals, with compassion and integrity, as they travel their pathway of life. "

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