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Choosing a Retirement Solution for Your Small Business

Choosing a Retirement Solution for Your Small Business.  To order copies call 1-866-444-3272.

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Starting a retirement savings plan can be easier than most business owners think. What’s more, there are a number of retirement programs that provide tax advantages to both employers and employees.

Why Save?

Experts estimate that Americans will need 70 to 90 percent of their preretirement income to maintain their current standard of living when they stop working. So now is the time to look into retirement plan programs. As an employer, you have an important role in helping America’s workers save.

By starting a retirement savings plan, you will help your employees save for the future. Retirement plans may also help you attract and retain qualified employees, and they offer tax savings to your business. You will help secure your own retirement as well. You can establish a plan even if you are self-employed.

Any Tax Advantages?

A retirement plan has significant tax advantages:

  • Employer contributions are deductible from the employer’s income,
  • Employee contributions (other than Roth contributions) are not taxed until distributed to the employee, and
  • Money in the plan grows tax-free.

Any Other Incentives?

In addition to helping your business, your employees and yourself, it is easy to establish a retirement plan, and there are additional reasons for doing so:

  • High contribution limits so you and your employees can set aside large amounts for retirement;
  • “Catch-up" rules that allow employees aged 50 and over to set aside additional contributions. The "catch-up" amount varies, depending on the type of plan;
  • A tax credit for small employers that enables them to claim a credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE, or certain other types of plans (more on these later). The credit equals 50 percent of the cost to set up and administer the plan, up to a maximum of $500 per year for each of the first 3 years of the plan;
  • A tax credit for certain low-and moderate-income individuals (including self-employed) who make contributions to their plans (“Saver’s Credit”). The amount of the credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent, depending on the participant’s adjusted gross income; and
  • A Roth program that can be added to a 401(k) plan to allow participants to make after-tax contributions into separate accounts, providing an additional way to save for retirement. Distributions upon death or disability or after age 59½ from Roth accounts held for 5 years, including earnings, are generally tax-free.

A Few Retirement Facts

Most private-sector retirement vehicles are either Individual Retirement Arrangements (IRAs), defined contribution plans, or defined benefit plans.

People tend to think of an IRA as something that individuals establish on their own, but an employer can help its employees set up and fund their IRAs. With an IRA, the amount that an individual receives at retirement depends on the funding of the IRA and the earnings (or losses) on those funds.

Defined contribution plans are employer-established plans that do not promise a specific amount of benefit at retirement. Instead, employees or their employer (or both) contribute to employees’ individual accounts under the plan, sometimes at a set rate (such as 5 percent of salary annually). At retirement, an employee receives the accumulated contributions plus earnings (or minus losses) on the invested contributions.

Defined benefit plans, on the other hand, promise a specified benefit at retirement, for example, $1,000 a month. The amount of the benefit is often based on a set percentage of pay multiplied by the number of years the employee worked for the employer offering the plan. Employer contributions must be sufficient to fund promised benefits.

Small businesses may choose to offer IRAs, defined contribution plans, or defined benefit plans. Many financial institutions and retirement plan practitioners make available one or more of these retirement plans that have been pre-approved by the IRS.

IRA-Based Plans

Payroll Deduction IRA

SEP

Simple IRA Plan

Key Advantage

Easy to set up and maintain.

Easy to set up and maintain.

Salary reduction plan with little administrative paperwork.

Employer Eligibility

Any employer with one or more employees.

Any employer with one or more employees.

Any employer with 100 or fewer employees that does not currently maintain another retirement plan.

Employer's Role

Arrange for employees to make payroll deduction contributions. Transmit contributions for employees to IRA. No annual filing requirement for employer.

May use IRS Form 5305-SEP to set up the plan. No annual filing requirement for employer.

May use IRS Forms 5304-SIMPLE or 5305-SIMPLE to set up the plan. No annual filing requirement for employer. Bank or financial institution handles most of the paperwork.

Contributors to the Plan

Employee contributions remitted through payroll deduction.

Employer contributions only.

Employee salary reduction contributions and employer contributions.

Maximum Annual Contribution (per participant)
See www.irs.gov/retirement for annual updates.

$5,000 for 2012 and $5,500 for 2013. Participants age 50 or over can make additional contributions up to $1,000.

Up to 25% of compensation(1) but no more than $50,000 for 2012 and $51,000 for 2013.

Employee:$11,500 in 2012 and $12,000 in 2013. Participants age 50 or over can make additional contributions up to $2,500..

Employer:Either match employee contributions 100% of first 3% of compensation (can be reduced to as low as 1% in any 2 out of 5 yrs.); or contribute 2% of each eligible employee's compensation.(2)

Contributor's Options

Employee can decide how much to contribute at any time.

Employer can decide whether to make contributions year-to-year.

Employee can decide how much to contribute. Employer must make matching contributions or contribute 2% of each employee's compensation.

Minimum Employee Coverage Requirements

There is no requirement. Can be made available to any employee.

Must be offered to all employees who are at least 21 years of age, employed by the employer for 3 of the last 5 years and had compensation of $550 for 2012 and for 2013.

Must be offered to all employees who have earned income of at least $5,000 in any prior 2 years, and are reasonably expected to earn at least $5,000 in the current year.

Withdrawals, Loans and Payments

Withdrawals permitted anytime subject to federal income taxes; early withdrawals subject to an additional tax (special rules apply to Roth IRAs).

Withdrawals permitted anytime subject to federal income taxes, early withdrawals subject to an additional tax.

Withdrawals permitted anytime subject to federal income taxes, early withdrawals subject to an additional tax.

Vesting

Contributions are immediately 100% vested.

Contributions are immediately 100% vested.

Employee salary reduction contributions and employer contributions are immediately 100% vested.

Defined Contribution Plans

Profit Sharing

Safe Harbor 401(k)

Automatic Enrollment 401(k)

Traditional 401(k)

Key Advantage

Permits employer to make large contributions for employees.

Permits high level of salary deferrals by employees without annual nondiscrimination testing.

Provides high level of participation and permits high level of salary deferrals by employees. Also safe harbor relief for default investments.

Permits high level of salary deferrals by employees.

Employer Eligibility

Any employer with one or more employees.

Any employer with one or more employees.

Any employer with one or more employees.

Any employer with one or more employees.

Employer's Role

No model form to establish this plan. May need advice from a financial institution or employee benefit adviser. A minimum amount of employer contributions is required. Must file annual Form 5500.

No model form to establish this plan. May need advice from a financial institution or employee benefit adviser. A minimum amount of employer contributions is required. Must file annual Form 5500.

No model form to establish this plan. May need advice from a financial institution or employee benefit adviser. Must file annual Form 5500. May require annual nondiscrimination testing to ensure that plan does not discriminate in favor of highly compensated employees.

No model form to establish this plan. May need advice from a financial institution or employee benefit adviser. Must file annual Form 5500. Requires annual nondiscrimination testing to ensure that plan does not discriminate in favor of highly compensated employees.

Contributors to the Plan

Annual employer contribution is discretionary.

Employee salary reduction contributions and employer contributions.

Employee salary reduction contributions and maybe employer contributions.

Employee salary reduction contributions and maybe employer contributions.

Maximum Annual Contribution (per participant)
See www.irs.gov/retirement for annual updates.

Up to the lesser of 100% of compensation(1) or $50,000 for 2012 and $51,000 for 2013. Employer can deduct amounts that do not exceed 25% of aggregate compensation for all participants.

Employee: $17,000 in 2012 and $17,500 in 2013. Participants age 50 or over can make additional contributions up to $5,500.

Employer/Employee Combined: Up to the lesser of 100% of compensation(1) or $50,000 for 2012 and $51,000 for 2013. Employer can deduct (1) amounts that do not exceed 25% of aggregate compensation for all participants, and (2) all salary reduction contributions.

Employee: $17,000 in 2012 and $17,500 in 2013. Participants age 50 or over can make additional contributions up to $5,500.

Employer/Employee Combined: Up to the lesser of 100% of compensation(1) or $50,000 for 2012 ($51,000 for 2013).. Employer can deduct (1) amounts that do not exceed 25% of aggregate compensation for all participants, and (2) all salary reduction contributions.

Employee: $17,000 in 2012 and $17,500 in 2013. Participants age 50 or over can make additional contributions up to $5,500.

Employer/Employee Combined: Up to the lesser of 100% of compensation(1) or $50,000 for 2012 and $51,000 for 2013. Employer can deduct (1) amounts that do not exceed 25% of aggregate compensation for all participants, and (2) all salary reduction contributions.

Contributor's Options

Employer makes contribution as set by plan terms.

Employee can decide how much to contribute based on a salary reduction agreement. The employer must make either specified matching contributions or a 3% contribution to all participants.

Employees, unless they opt otherwise, must make salary reduction contributions specified by the employer. The employer can make additional contributions, including matching contributions as set by plan terms.

Employee can decide how much to contribute based on a salary reduction agreement. The employer can make additional contributions, including matching contributions as set by plan terms.

Minimum Employee Coverage Requirements

Generally, must be offered to all employees at least 21 years of age who worked at least 1,000 hours in a previous year.

Generally, must be offered to all employees at least 21 years of age who worked at least 1,000 hours in a previous year.

Generally, must be offered to all employees at least 21 years of age who worked at least 1,000 hours in a previous year.

Generally, must be offered to all employees at least 21 years of age who worked at least 1,000 hours in a previous year.

Withdrawals, Loans and Payments

Withdrawals permitted after a specified event occurs (e.g., retirement, plan termination, etc.) subject to federal income taxes. Plan may permit loans and hardship withdrawals; early withdrawals subject to an additional tax.

Withdrawals permitted after a specified event occurs (e.g., retirement, plan termination, etc.) subject to federal income taxes. Plan may permit loans and hardship withdrawals; early withdrawals subject to an additional tax.

Withdrawals permitted after a specified event occurs (e.g., retirement, plan termination, etc.) subject to federal income taxes. Plan may permit loans and hardship withdrawals; early withdrawals subject to an additional tax.

Withdrawals permitted after a specified event occurs (e.g., retirement, plan termination, etc.) subject to federal income taxes. Plan may permit loans and hardship withdrawals; early withdrawals subject to an additional tax.

Vesting

May vest over time according to plan terms.

Employee salary reduction contributions and most employer contributions are immediately 100% vested. Some employer contributions may vest over time according to plan terms.

Employee salary reduction contributions are immediately 100% vested. Employer contributions may vest over time according to plan terms.

Employee salary reduction contributions are immediately 100% vested. Employer contributions may vest over time according to plan terms.

Defined Benefit Plans

Key Advantage

Provides a fixed, pre-established benefit for employees.

Employer Eligibility

Any employer with one or more employees.

Employer's Role

No model form to establish this plan. Advice from a financial institution or employee benefit adviser would be necessary. Must file annual Form 5500. An actuary must determine annual contributions.

Contributors to the Plan

Primarily funded by employer.

Maximum Annual Contribution (per participant)
See www.irs.gov/retirement for annual updates.

Annually determined contribution.

Contributor's Options

Employer generally required to make contribution as set by plan terms.

Minimum Employee Coverage Requirements

Generally, must be offered to all employees at least 21 years of age who worked at least 1,000 hours in a previous year.

Withdrawals, Loans and Payments

Payment of benefits after a specified event occurs (e.g. retirement, plan termination, etc.). Plan may permit loans; early withdrawals subject to an additional tax.

Vesting

May vest over time according to plan terms.

Payroll Deduction IRAs

Even if an employer does not want to adopt a retirement plan, the employer can allow its employees to contribute to an IRA through payroll deductions, providing a simple and direct way for employees to save. In this type of arrangement the employee always makes the decisions about whether, when, and how much to contribute to the IRA (up to $5,000 in 2012 and $5,500 in 2013, and $6,000 in 2012 and $6,500 in 2013 if age 50 or older, increasing thereafter).

Some employees eligible to contribute to an IRA wait until the end of the year to set aside the money and then find that they do not have sufficient funds to do so. Payroll deductions allow employees to plan ahead and save smaller amounts each pay period. Payroll deduction contributions are tax-deductible by the employee, to the same extent as other IRA contributions.

Simplified Employee Pensions (SEPs)

A SEP plan allows employers to set up SEP IRAs for themselves and each of their employees. Employers must contribute a uniform percentage of pay for each employee, although they do not have to make contributions every year. Employer contributions are limited to the lesser of 25 percent of pay or $50,000 in 2012 and $51,000 in 2013. (Note: the dollar amount is indexed for inflation and may increase.) Most employers, including those who are self-employed, can establish a SEP.

SEPs have low start-up and operating costs and can be established using a two-page form. And you can decide how much to put into a SEP each year – offering you some flexibility when business conditions vary.

SIMPLE IRA Plans

A SIMPLE IRA plan is a savings option is for employers with 100 or fewer employees.

This plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. Under SIMPLE IRA plans, employees can set aside up to $11,500 in 2012 and $12,000 in 2013 ($14,000 in 2012 and $14,500 in 2013 if age 50 or older), by payroll deduction (subject to cost-of-living adjustments in later years). Employers must either match employee contributions dollar for dollar – up to 3 percent of an employee’s compensation – or make a fixed contribution of 2 percent of compensation for all eligible employees, even if the employees choose not to contribute.

If your plan provides for it, you can choose to automatically enroll employees in SIMPLE IRA plans as long as the employees are allowed to choose not to have salary reduction contributions made to their SIMPLE IRAs or to have salary reduction contributions made in a different amount.

SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs (to hold contributions made under the SIMPLE IRA plan) are established for each employee. A financial institution can do much of the paperwork. Additionally, administrative costs are low.

You may either have your employees set up their own SIMPLE IRAs at a financial institution of their choice or have all SIMPLE IRAs maintained at one financial institution you choose.

Employees can decide how and where the money will be invested, and keep their SIMPLE IRAs even when they change jobs.

Profit Sharing Plans

Employer contributions to a profit sharing plan can be discretionary. Depending on the plan terms, there is often no set amount that an employer needs to contribute each year.

If you do make contributions, you will need to have a set formula for determining how the contributions are allocated among plan participants. The funds are accounted separately for each employee.

Profit sharing plans can vary greatly in their complexity. Similarly, many financial institutions offer prototype profit sharing plans that can reduce the administrative burden on individual employers.

401(k) Plans

401(k) plans have become a widely accepted retirement savings vehicle for small businesses. According to the most recent data, an estimated 51 million U.S. workers participate in 401(k) plans that have total assets of about $3 trillion.

With a 401(k) plan, employees can choose to defer a portion of their salary. So instead of receiving that amount in their paycheck today, the employees can contribute the amount into a 401(k) plan sponsored by their employer. These deferrals are accounted separately for each employee. Deferrals are made on a pretax basis but if the plan allows, they can be made on an after-tax (Roth) basis at the employee's choosing. Many 401(k) plans provide for employer matching or other contributions. The Federal Government and most state governments do not tax employer contributions and pretax deferrals (plus earnings) until distributed.

Like most profit sharing plans, 401(k) plans can vary significantly in their complexity. However, many financial institutions and other organizations offer prototype 401(k) plans, which can greatly lessen the administrative burden on individual employers of establishing and maintaining these plans.

Safe Harbor 401(k) Plans

A safe harbor 401(k) plan is intended to encourage plan participation among rank-and-file employees and to ease administrative burden by eliminating the tests ordinarily applied under a traditional 401(k) plan. This plan is ideal for businesses with highly compensated employees whose contributions would be limited in a traditional 401(k) plan.

A safe harbor 401(k) plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. In a safe harbor 401(k) plan, the mandatory employer contribution is always 100 percent vested.

Automatic Enrollment 401(k) Plans

Automatic enrollment 401(k) plans can increase plan participation among rank-and-file employees and make it more likely that the plan will pass the tests ordinarily required under a traditional 401(k) plan. Some automatic enrollment 401(k) plans are exempt from the testing. This plan is for employers who want a high level of participation, and who have highly compensated employees whose contributions might be limited under a traditional 401(k) plan.

Employees are automatically enrolled in the plan and contributions are deducted from their paychecks, unless they opt out of contributing after receiving notice from the plan. There are default employee contribution rates, which may rise incrementally over the first few plan years, although the employer can choose different amounts. In addition, for certain default investment options provided under the plan, there is relief from liability for the investment results.

Defined Benefit Plans

Some employers find that defined benefit plans offer business advantages. For instance, businesses can generally contribute (and therefore deduct) more each year than in defined contribution plans. In addition, employees often value the fixed benefit provided by this type of plan and can often receive a greater benefit at retirement than under any other type of retirement plan. However, defined benefit plans are often more complex and, likely, more expensive to establish and maintain than other types of plans.

To Find Out More…

The following jointly developed publications are available for small businesses on the DOL and IRS websites and through the toll-free numbers listed below:

And for business owners with plans:

DOL website: www.dol.gov/ebsa
Publications request number: 1-866-444-3272

IRS website: www.irs.gov/retirement
Tax form and publication ordering number: 800-TAX FORM (829-3676), you can place your order 24 hours a day, 7 days a week.

Also available from the U.S. Department of Labor

Two interactive websites to help you find the appropriate plan option(s) for you

Publications for plan officials:

Also available from the Internal Revenue Service

Footnotes

  1. Maximum compensation on which 2012 contributions can be based is $250,000 ($255,000 for 2013).
  2. Maximum compensation on which 2012 employer 2% non-elective contributions can be based is $250,000 ($255,000 for 2013).

This pamphlet is a joint project of the U.S. Department of Labor's Employee Benefits Security Administration (EBSA) and the Internal Revenue Service. Its publication does not constitute legal, accounting, or other professional advice. It does, however, constitute a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.

To order publications or request assistance from a benefits advisor, contact EBSA electronically at www.askebsa.dol.gov or call toll free at 1-866-444-3272. It is also available from the IRS by calling 800-TAX FORM (829-3676). Please indicate publication number 3998 or catalog number 34066S when ordering.

This publication will be made available in alternative format to persons with disabilities upon request. Voice Phone: (202) 693-8664, TDD Phone: (202) 501-3911.