The Basics of Employee Benefits

Retirement Plans

A big mistake some business owners make is thinking they can't afford to fund a retirement plan in lieu of putting profits back into the business. But less than half of the employees at small companies participate in retirement plans. And companies that do offer this benefit report increased employee retention and happier, more efficient workers. Also, don't forget about yourself: Many business owners are at risk of having insufficient funds saved for retirement.

To encourage more businesses to launch retirement plans, the Economic Growth and Tax Relief Reconciliation Act of 2001 provides a tax credit for costs associated with starting a retirement plan, including a 401(k) plan, SIMPLE plan or Simplified Employee Pension (SEP). The credit equals 50 percent of the first $1,000 of qualified startup costs, including expenses to set up and administer the plan and educate employees about it. For more information, see IRS Form 8881, Credit for Small Employers Pension Plan Start-up Costs (PDF).

Don't ignore the value of investing early. If, starting at age 35, you invested $3,000 each year with a 14-percent annual return; you would have an annual retirement income of nearly $60,000 at age 65. But $5,000 invested at the same rate of return beginning at age 45 only results in $30,700 in annual retirement income. The benefit of retirement plans is that savings from tax-free until you withdraw the funds--typically age 59. If you withdraw funds before that age, the withdrawn amount is fully taxable and also subject to a 10-percent penalty. The value of tax-free investing over time means it's best to start right away, even if you start with small increments.

Besides the long-term benefit of providing for your future, setting up a retirement plan also has the immediate gratification of cutting taxes

Here is a closer look at a range of retirement plans for yourself and your employees.

Individual Retirement Account (IRA)

An IRA is a tax-qualified retirement savings plan available to anyone who works and/or their spouse, whether the individual is an employee or a self-employed person. One of the biggest advantages of these plans is that the earnings on your IRA grow on a tax-deferred basis until you start withdrawing the funds. Whether your contribution to an IRA is deductible will depend on your income level and whether you're covered by another retirement plan at work.

You also may want to consider a Roth IRA. While contributions are not tax deductible, withdrawals you make at retirement will not be taxed. The maximum annual contribution individuals can put in either a Roth or a traditional IRA is $3,000 for 2004, assuming they meet the eligibility requirements.

To qualify for Roth IRA contributions, a single person's adjusted gross income (AGI) must be less than $95,000, with benefits phasing out completely at $110,000. For married couples filing jointly, the AGI must be less than $150,000. The contribution amount is decreased by 30 percent (35 percent if 50 or older) until it is eliminated completely at $160,000 for joint filers. For 2005 to 2007, the contribution limit for both single and joint filers climbs to $4,000 per person and to $5,000 per person in 2008. After that, contributions and indexed to inflation.

Regardless of income level, you can qualify for a deductible IRA as long as you do not participate in an employer-sponsored retirement plan, such as a 401 (k). If you are in an employer plan, you can qualify for a deductible IRA if you meet the income requirements. Keep in mind that it's possible to set up or make annual contributions to an IRA any time you want up to the date your federal income tax return is due for that year, not including extensions. The contribution amounts for deductible IRA's are the same as for Roth IRA's.

For joint filers, even if one spouse is covered by a retirement plan, the spouse who is not covered by a plan may make a deductible IRA contribution if the couple's adjusted gross income is $150,000 or less. Like the Roth IRA, the amount you can deduct is decreased in stages above that income level and is eliminated entirely for couples with incomes over 160,000. Nonworking spouses and their working partners can contribute up to $6,000 to IRAs ($3,000 each), provided the working spouse earns at least $6,000. It's possible to contribute an additional $500 for each spouse who is at least 50 years old at the end of the year, as long as there is the necessary earned income. For example, two spouses over 50 could contribute a total of $7,000 if there is at least $7,000 of earned income.

Saving Incentive Match Plan For Employees (SIMPLE)

SIMPLE plans are one of the most attractive options available for small-business owners. With these plans, you can choose to use a 401(k) or an IRA as your retirement plan.

A SIMPLE plan is just that--simple to administer. This type of retirement plan doesn't come with a lot of paperwork and reporting requirements.

You can set up a SIMPLE IRA only if you have 100 or fewer employees who have received $5,000 or more in compensation from you in the preceding year. The employer must make contributions the plan by either matching each participating employee's contribution, dollar for dollar, up to 3 percent of each employee's pay, or by making an across-the-board 2-percent contribution for all employees, even if they don't participate in the plan, which can be expensive.

The maximum amount each employee can contribute to the plan can't be more than $9,000 for 2004; the amount increases to $10,000 in 2005. After that, the amount will be indexed for inflation. Participants in a SIMPLE IRA who are age 50 or over at the end of the calendar year can also make a catch-up contribution of an additional $1,500 in 2004, $2,000 in 2005 and $2,500 in 2006.

Simplified Employee Pension (SEP) Plan

As its name implies, this is the simplest type of retirement plan available. Essentially, a SEP is a glorified IRA that allows you to contribute a set percentage up to a maximum amount each year. Paperwork is minimal, and you don't have to contribute every year. And regardless of the name, you don't need employees to set one up.

If you do have employees(well, that's the catch. Employees do not make any contributions to SEPS. Employers must pay the full cost of the plan, and whatever percentage you contribute for yourself must be applied to al eligible employees. The maximum contribution is 25 percent of an employee's compensation (up to a maximum of $200,000) or $40,000, whichever is less.

KOEGH Plan

A KEOGH retirement plan can be set up by self-employed individuals and doesn't require advanced IRS approval. There are two types of KEOGH plans available. One is defined-benefit, which allows participants to contribute a maximum of the lesser of either 100 percent of their average compensation for the three consecutive years of highest compensation as an active participant, or $170,000. Then there's defined contribution, which allows for contributions of up to $42,000 for either a profit-sharing defined contribution plan or a money-purchase plan. The deadline for setting up a KEOGH plan is the end of the tax year (December 31), and the deadline for making contributions to the KEOGH plan is the same as the SEP--the due date for your Form 1040 individual tax return (including extensions). 401(k) Plans
401(k) plans take their name from the section of the federal tax code that provides for them. These plans let you and your employees set aside a percentage of salary tax-free every year. As a kicker, the funds grow tax-free until they're withdrawn. 401(k) plans are very popular benefits with employees because they allow you--the employer--to essentially pay workers more without that income being taxed. Compared to SEPs, 401(k) plans are more popular with employers because most of the contribution comes from the employees.

The Employee Retirement Income Security Act of 1974 (ERISA) governs the way 401(k) plans are set up and managed. There are many responsibilities that go with setting up a 401(k) program. For instance, you or someone you select has to determine the investment options employees will get to choose from. You have to monitor the investment's performance as well as the service provided by whomever is administering your plan. ERISA exists to make sure any fees that are charged are "reasonable." Setting up a 401(k) is a complicated procedure governed by many arcane rules. You should never do it without consulting with a qualified tax advisor.

Where to Go

With so many choices available, it's good idea to talk to your accountant about which type of plan is best for you. Once you know what you want, where do you go to set up a retirement plan?

  • Savings certificates (often at higher yields than at banks or savings and loans)
  • Personal and auto loans
  • Lines of credit
  • Checking accounts
  • Christmas club accounts

Only state-chartered credit unions are allowed to add new companies to their membership rosters. To find a credit union that will accept your company, call your state's league of credit unions .

When comparing credit unions, get references and check them. Find out how communicative and flexible the credit union is. Examine the accessibility. Are there ATMs? Is there a location near your business? Consider the end users--your employees.

Once your company is approved, designate one person to be the primary liaison with the credit union. That person will maintain information about memberships as well as enrollment forms and loan applications. Kick things off by asking accredit union representative to conduct on-site enrollment and perhaps return periodically for follow-up or new sign-ups.

This how-to was excerpted from Start Your Own Business, Grow Your Business and "Selecting the Right Retirement Plan" by David Meier.

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