Which Retirement Plan is Best for your Small Business? A 2021 poll found that 59% of Americans don't believe they will ever save enough to retire. In fact, a 2020 PwC survey found that 25% of American adults have...
This story originally appeared on Due
A 2021 poll found that 59% of Americans don't believe they will ever save enough to retire. In fact, a 2020 PwC survey found that 25% of American adults have no retirement savings at all. Those who do aren't saving nearly enough in their retirement plans.
Making things more difficult is that smaller companies often don't know how to best assist employees with their retirement plans. Small businesses have tight margins. So, even though health benefits and retirement plans improve employee satisfaction, they're on the cutting block as the economy worsens and business leaders seek cost-saving measures.
Due to these factors, choosing a retirement plan is difficult for business leaders. There are many types of retirement plans, and each has significantly different rules and pros and cons. Another thing that makes choosing a company retirement plan challenging is that there are many regulations that are hard to understand if you don't work in the retirement space.
That's why small business owners should sit down with specialized service providers who can help them figure out what's needed. They can review the best retirement plans and determine which fits leaders' personalized business situations. Cutting employee benefits such as retirement can be detrimental to businesses in the long run. But the move can be avoided with the right strategies.
Benefits of retirement plans
The scope of retirement has changed over the generations. American Express started private pensions in 1875, which gained popularity in the 1920s as workers' unions formed. Corporations and governments sought ways to provide long-term benefits for workers, and private pension plans were often generous.
However, pension funds were entirely paid by corporations. They hit trouble by the 1970s as inflation and rising costs increased overheads. The IRS stepped in with the 1978 Revenue Act, which provided a way for employers and employees to share the costs of investing in retirement. It wasn't long before pensions proliferated to become the most common retirement plan offered by Fortune 500 companies.
Getting retirement plans right — as many companies did with pension funds — can help a business in many ways. Here are some benefits of retirement plans, so long as you find the right retirement plan to fit your business's and employee's needs:
Retirement plans keep employees satisfied.
Retirement plans make it simple and quick for your employees to save. With the right plan, they can easily keep costs low in their accounts and see the benefit from the employer match (if you offer one). This helps raise morale and attract and retain top talent.
Company-sponsored retirement plans that offer employee and employer contributions give your employees a boost so they can get ahead. With that kind of benefit, word will quickly spread that you prioritize your team. In turn, you can raise your profile throughout the industry as an excellent company to work for.
In fact, 60% of respondents to a 2022 survey cite their retirement plans as important reasons to stay with their current employers. And nearly half say retirement benefits were important reasons to join companies in the first place. Both numbers rose double digits from a little over a decade ago, showing just how important retirement plans continue to be for workers.
Retirement plans help business owners achieve their financial goals.
Retirement isn't just for employees. Business owners often have much of their wealth tied to their businesses. This is true of both small business owners and the wealthiest tycoons in the world, such as Elon Musk and Jeff Bezos. There is nothing wrong with that. However, it's critical to put some money aside to diversify your wealth.
This becomes much more important if your business won't eventually be "sellable" at a significant level. That's because small businesses often sell for only two to three times their earnings. In my experience, companies that provide a service, such as dentist offices and marketing firms, don't sell for more than a year or two of their revenue.
It's rare for a business to sell for more than five times its annual earnings. Even that isn't enough to retire with. Of course, entrepreneurs and business owners often have exit strategies to unload their businesses. But you should also be aware of your personal retirement plan and consider your eventual exit from the workforce.
Retirement plans don't have to add cost- or time-intensive strain on the business.
Although you want a retirement plan that benefits yourself and your employees, you also want to add value to the business. Implementing a retirement plan that requires significant time or money to operate won't add to the business and could have a negative impact.
Your company must be sustainable to provide for your team, and inflation already has many people feeling financially strained and pessimistic. The global pandemic highlighted just how fragile many people's financial situations are. In a 2022 survey, 7 in 10 Americans report that inflation is a big problem for the country. And only about 30% of people in the U.S. are very confident about living comfortably in retirement.
Providing a retirement safety net is important, as we see record numbers of Baby Boomers and Gen Xers delay retirement to stay in the workforce. Even before the pandemic, more than half (53%) of people aged 54-72 were still working.
Three common types of retirement plans
Providing the most benefit with your company retirement plan requires choosing the right one. There are three main types of retirement plans small businesses should consider, each with pros and cons. Your chosen retirement plan will depend on your specific situation, as there is no one-size-fits-all approach. In addition, be sure to consult with an expert to ensure you're addressing your unique needs.
SIMPLE IRA plan.
A Savings Incentive Match Plan for Employees Individual Retirement Account (or a SIMPLE IRA) is an employer-sponsored retirement plan meant to be simple. Any employer with 100 or fewer employees qualifies for this retirement account. In addition, employees who earn at least $5,000 per year are eligible to participate. Although you can loosen these restrictions, you cannot make them stricter.
Employees can contribute up to $14,000 in 2022 ($17,000 if they're 50 or older), and employers can match employee contributions dollar-for-dollar up to 3%. This provides strong motivation for employees to save and max out the free money from their employers.
- SIMPLE IRA retirement plans are easy to run and administer.
- The plans have low costs for both employer and employees (there are usually no service provider costs if done properly).
- They often have low savings limits for business owners (typically less than $20,000 annually).
- The plans don't offer much flexibility on contributions to employees.
Employees who sign up for 401(k)s agree to have set percentages of their wages redirected into investment accounts. Employers can match all or part of employees' contributions, and employees can choose from wide ranges of investment options to fit their personal needs.
These retirement plans are deducted from gross (or pre-tax) income, which can reduce the employee's tax liability for the year. Taxes in a standard 401(k) are paid when the money is withdrawn during retirement. If the funds are withdrawn early, fees apply.
Employers can also choose to provide Roth 401(k)s that move tax liability upfront. This is preferable for employees who will have more money later in life (a normal scenario, as people often get raises over time). If you do provide the option of a Roth 401(k), make sure your employees are trained on the tax implications of both 401(k)s and Roth 401(k)s. That way, they can choose the best one for their needs.
- 401(k)s offer flexible contribution matches for employees.
- They are widely recognized benefits and can help with recruiting.
- Provider costs can be kept low if a lot of due diligence is practiced.
- The plans have very high savings amounts for owners (typically over $60,000 annually).
- Discrimination tests from the U.S. Department of Labor can require more contributions to employees or refunds from owners.
- Service provider costs are much higher than with SIMPLE IRAs.
Cash balance plan.
A cash balance retirement plan is usually provided in combination with a 401(k). With these retirement plans, employers make contributions on behalf of participants. Cash balance retirement plans have much higher contribution amounts than 401(k)s and grow tax-deferred at set interest rates.
This removes the risk of investing in the market, especially during recessions or depressions. Instead, participants get guaranteed returns and compound interest that are not affected by market conditions. However, there's no guarantee that contributions will outpace inflation.
The IRS has stringent rules regarding cash balance plans, so be sure you fully read and understand them before implementing one. The very last thing you need is the added expense of failing an IRS audit because something simple is missing from your retirement plan.
- Cash balance retirement plans have extremely high savings amounts for owners (can be over $200,000 per year).
- They allow for higher employer contributions to employees.
- Plans have high contributions required from businesses to employees.
- Cash balance retirement plans often have high service provider costs ($15,000 or more annually).
- They require very specialized advice and business planning.
Determining the best plan
When deciding which retirement plan to offer, there are a few questions you should ask, such as:
- How much do you want to save? Although rules on employee retirement are relatively easy to understand, you have different rules as the business owner. You're part of the team as well, and you deserve a retirement safety net for risking your money in a business venture. Make sure you select a retirement option that benefits you and your employees — without sacrificing business needs.
- How much cash flow are you ready to commit to the retirement plan, both for service provider costs and contribution matches? It would be nice to offer your employees the world, but that isn't an economically viable option for your business. You can only spend the money you have, and you can't afford to tie up too much liquidity in retirement plans by offering huge employer matches. Ultimately, you need to ensure your business has enough cash flow to continue running.
- What is the primary goal of your company's retirement plan? Are you looking to recruit and retain top talent? Do you need to save as much money as possible? These are the questions to ask that will ultimately determine which retirement plan is best for your business. Once you've identified the goals of your retirement plan, you can select the right retirement benefits for your situation.
Reap long-term benefits of retirement plans
Getting your retirement plan right from the get-go makes things much more straightforward. Having a system also makes it easier to run your business and ensures your retirement plan benefits employees. Proper planning reduces the resources needed to manage benefits. Plus, it helps keep retirement plans off the chopping block when economic conditions become turbulent.
Unfortunately, many businesses and people end up in debt, which can negatively affect your retirement savings. Balancing this is challenging, especially when scaled up to apply to 100 people or more as your company grows.
I have seen some retirement plans become a burden not only to a business, but also its employees. What starts as a positive benefit becomes viewed as a negative one by employees because costs are too high and the right service providers aren't hired. A poorly planned retirement plan could end up doing more harm than good in the long run.
So, you should have at least one service provider proactively trying to improve your retirement plan. As your business changes, so too must your benefits. You need someone willing to adapt with your business, rather than a one-and-done provider.
With a well-thought-out retirement plan that fits your needs, resources, and budget, it shouldn't be difficult to implement a plan. Once you do, you'll notice the boost in morale as employees know they will be on solid footing well into their golden years. A retirement plan can save money, boost revenue, and give you and your employees a comfortable future.
The post Which Retirement Plan is Best for your Small Business? appeared first on Due.