Over the past few decades retirement planning for Americans has undergone a sea of change. Gone are the days when most employees received defined benefit pension plans from their employers that guaranteed a certain level of income at retirement.
Now most companies offer what are known as defined contribution retirement plans, in which employees are primarily responsible for saving for their own retirements, perhaps with some help from their employers in the form of matching contributions. The good news is that the federal government provides some extremely attractive tax benefits to companies that offer a qualified defined contribution retirement plan to their employees.
The most popular retirement plan offered by U.S. companies is the 401(k) plan. Employees make tax-deductible contributions that can be matched by their employers, who also receive a tax deduction for their contributions (as long as they don’t exceed certain limitations). In tax year 2009, employees and employers could contribute up to $16,500 per year to a 401(k) account, or $22,000 for employees age 50 or older.
To make it easier for small companies to allow their employees to participate in 401(k) plans, the federal government introduced SIMPLE 401(k)s. Any company with 100 employers or fewer may be eligible to offer a SIMPLE 401(k) plan and receive the same tax benefits as a traditional 401(k).
Roth 401(k)s are another option. These allow employees to save money for retirement on an after-tax basis but enjoy tax-free accumulation of earnings and withdrawals. Unlike a traditional 401(k), employees cannot deduct contributions from their current income, but this is offset by the ability to withdraw funds tax-free after they retire. Employers can also make discretionary matching contributions with pretax dollars that accumulate in a separate traditional 401(k) account that will be taxed as ordinary income when withdrawn at retirement.
The simplest qualified retirement plan option is what’s known as a simplified employee pension plan, or SEP. It’s especially attractive to self-employed individuals because SEPs are funded completely by employers. In this sense, SEPs are more like traditional defined benefit pension plans than they are 401(k) plans because employees don’t contribute anything to the plans. However, self-employed individuals can make tax-deductible contributions to SEP accounts for themselves of up to $49,000 per year in tax year 2009.
SEPs do provide a great deal of flexibility because you can vary contributions for yourself and your employees from one year to the next. So if you have a year in which profits are down, you can lower SEP contributions or skip them altogether if you choose.
Another option is the SIMPLE IRA. Like the 401(k), this plan allows both employees and employers to make tax-deductible contributions. Employer contributions are made according to a matching formula and are mandatory each year for all employees who participate. The 2009 contribution limit for SIMPLE IRAs is $11,500, or $14,000 for employees who are age 50 or older.
Keep in mind that as the sponsor of a retirement plan, you must meet specific fiduciary duties. In particular, the Employee Retirement Income Security Act (or ERISA) states that qualified retirement plans must be created for the exclusive benefit of your employees.
While this doesn’t mean that your company cannot benefit from offering retirement plans by receiving tax deductions and increasing employee retention, it does mean that plans cannot be deemed to be “discriminatory.” Or in other words, qualified plans cannot benefit company owners, executives, and other highly compensated employees in a proportionally greater amount than they benefit rank-and-file employees.
Don Sadler is a freelance writer and editor specializing in business and finance.