The Basics of Employee Benefits
What's required? What's not? And what's just good policy? This primer will help you figure it out.
Once you have great employees on board, how do you keep them from jumping ship? One way is by offering a good benefits package.
Many small-business owners mistakenly believe they cannot afford to offer benefits. But while going without benefits may boost your bottom line in the short run, than penny-wise philosophy could strangle your business's chances for long-term prosperity. "There are certain benefits good employees feel they must have," says Ray Silverstein, founder of PRO, President's Resource Organization, a small-business advisory network.
Heading the list of must-have benefits is medical insurance, but many job applicants also demand a retirement plan, disability insurance and more. Tell these applicants no benefits are offered, and often top-flight candidates will head for the door.
The positive side to this coin: Offer the right benefit, and your business may just jump-start its growth. "Give employees the benefits they value, and they'll be more satisfied, miss fewer workdays, be less likely to quit, and have higher commitment to meeting the company's goals," says Joe Lineberry, a senior vice president at Aon Consulting, a human resources consulting firm. "The research shows that when employees feel their benefits needs are satisfied, they're more productive."
The law requires employers to provide employees with certain benefits. You must:
- Give employees time off to vote, serve on a jury and perform military service.
- Comply with all workers' compensation requirements.
- Withhold FICA taxes from employees' paychecks and pay your own portion of FICA taxes, providing employees with retirement and disability benefits.
- Pay state and federal unemployment taxes, thus providing benefits for unemployed workers.
- Contribute to state short-term disability programs in states where such programs exist.
- Comply with the Federal Family and Medical Leave (FMLA).
You are not required to provide:
- Retirement plans
- Health plans (except in Hawaii)
- Dental or vision plans
- Life insurance plans
- Paid vacations, holidays or sick leave
In reality, however, most companies offer some or all of these benefits to stay competitive.
Most employers provide paid holidays for New Year's, Memorial Day, Independence Day, Labor Day and Thanksgiving day and Christmas day. Many employers also either allow their employees to take time off without pay or let them use vacation days for religious holidays. (See more on time off in "The Low-Cost Benefits of Offering Time Off" ).
Most full-time employees will expect one to two weeks paid vacation time per year. In explaining your vacation policy to employees, specify how far in advance requests for vacation time should be made, and whether in writing or verbally. There are no laws that require employers to provide funeral leave, but most do allow two to four days' leave for deaths of close family members.
The federal Family and Medical Leave Act (FMLA) requires employers to give workers up to 12 weeks off to attend to the birth or adoption of a baby, or the serious health condition of the employee or an immediate family member. After 12 weeks of unpaid leave, you must reinstate the employee in the same job or an equivalent one. The 12 weeks of leave does not have to be taken all at once; in some cases, employees can take it a day at a time.
In most states, only employers with 50 or more employees are subject to the Family and Medical Leave Act. However, some states have family leave laws that place family leave requirements on businesses with as few as five employees. To find out your state's requirements, contact you state labor department.
Complications quickly arise as soon as business begins offering benefits, however. That's because key benefits such as health insurance and retirement plans fall under government scrutiny, and "it is very easy to make mistakes in setting up a benefits plan," says Kathleen Meagher, an attorney specializing in benefits at Kirkpatrick Lockhart LLP.
And don't think nobody will notice. The IRS can discover in an audit what you are doing doesn't comply with regulations. So can the U.S. Department of Labor, which has been beefing up its audit activities of late. Either way, a goof can be very expensive. "You can lose any tax benefits you have enjoyed, retroactively, and penalties can also be imposed," Meagher says.
The biggest mistake? Leaving employees out of the plan. Examples range from exclusions of part-timers to failing to extend benefits to clerical and custodial staff. A rule of thumb is that if one employee gets a tax-advantaged benefit--meaning one paid for with pretax dollars--the same benefit must be extended to everyone. There are loopholes that may allow you to exclude some workers, but don't even think about trying this without expert advice.
Such complexities mean its good advice never to go this route alone. You can cut costs by doing preliminary research yourself, but before setting up any benefits plan, consult a lawyer or a benefits consultant. An upfront investment of perhaps $1,000 could save you far more money down the road by helping you sidestep expensive potholes.
Providing benefits that meet employee needs and mesh with all the laws isn't cheap--benefits probably add 30 to 40 percent to base pay for most employees--and that makes it crucial to get the most from these dollars. But this is exactly where many small businesses fall short because often their approach to benefits is riddled with costly errors that can get them in financial trouble with their insurers or even with their own employees. The most common mistakes:
- Absorbing the entire cost of employee benefits. Fewer companies are footing the whole benefits bill these days. According to a survey of California companies by human resources management consulting firm William M. Mercer, 91 percent of employers require employee contributions toward health insurance, while 92 percent require employees to contribute toward the cost of insuring dependants. The size of employee contributions varies from a few dollars per pay period to several hundred dollars monthly, but one plus of any co-payment plan is it eliminates employees who don't need coverage. Many employees are covered under other policies--a parent's or spouses, for instance--and if you offer insurance for free, they'll take it. But even small co-pay requirements will persuade many to skip it, saving you money.
- Covering nonemployers. Who would do this? Lots of business owners want to buy group-rate coverage for their relatives or friends. The trouble: If there is a large claim, the insurer may want to investigate. And that investigation could result in disallowance of the claims, even cancellation of the whole policy. Whenever you want to cover somebody who might not qualify for the plan, tell the insurer or your benefits consultant the truth.
- Sloppy paperwork. In small businesses, administering benefits is often assigned to an employee who wears 12 other hats. This employee really isn't familiar with the technicalities and misses a lot of important details. A common goof: Not enrolling new employees in plans during the open enrollment period. Most plans provide a fixed time period for open enrollment. Bringing an employee in later requires proof of insurability. Expensive litigation is sometimes the result. Make sure the employees overseeing this task stays current with the paperwork and knows that doing so is a top priority.
- Not telling employees what their benefits cost. "Most employees don't appreciate their benefits, but that's because nobody ever tells them what the costs are," says PRO's Silverstein. Many experts suggest you annually provide employees with a benefits statement that spells out what they're getting and at what cost. A simple rundown of the employee's individual benefits and what they cost the business is very powerful.
- Giving unwanted benefits. A workforce composed largely of young, single people doesn't need life insurance. How to know what benefits employee's value? You can survey employees and have them rank benefits in terms of desirability. Typically, medical and financial benefits, such as retirement plans, appeal to the broadest cross-section of workers.
If workers needs vary widely, consider the increasingly popular " cafeteria plans ," which give workers lengthy lists of possible benefits plus a fixed amount to spend.
Health insurance is one of the most desirable benefits you can offer employees. There are several basic options for setting up a plan:
- A traditional indemnity plan, or fee for service. Employees choose their medical care provider; the insurance company either pays the provider directly or reimburses employees for covered amounts.
- Managed care. The two most common forms of managed care are the Health Maintenance Organization (HMO) and the Preferred Provider Organization (PPO). An HMO is essentially a prepaid health-care arrangement, where employees must use doctors employed by or under contract to the HMO and hospitals approved by the HMO. Under a PPO, the insurance company negotiates discounts with the physicians and the hospitals. Employees choose doctors from an approved list, then usually pay a set amount per office visit (typically $10 to $25); the insurance company pays the rest.
- Self insurance. When you absorb all or a significant portion of a risk, you are essentially self-insuring. An outside company usually handles the paperwork, you pay the claims and sometimes employees help pay premiums. The benefits include greater control of the plan design, customized reporting procedures and cash-flow advantages. The drawback is that you are liable for claims, but you can limit liability with "stop loss" insurance--if a claim exceeds a certain dollar amount, the insurance company pays it.
- Archer Medical Savings Account. : Under this program, an employee of a small employer (50 or fewer employees) or a self-employed person can set up an Archer MSA to help pay health-care expenses. The accounts are set up with a U.S. financial institution and allow you to save money exclusively for medical expenses. When used in conjunction with a high-deductible insurance policy, accounts are funded with employee's pretax dollars. Under the Archer MSA program, disbursements are tax-free if used for approved medical expenses. Unused funds in the account can accumulate indefinitely and earn tax-free interest. Health-savings accounts (HSAs), available as of January 2004, are similar to MSAs but are not restricted to small employers.
The rising costs of health insurance have forced some small businesses to cut back on the benefits they offer. Carriers that write policies for small businesses tend to charge very high premiums. Often, they demand extensive medical information about each employee. If anyone in the group has a pre-existing condition, the carrier may refuse to write a policy. Or, if someone in the company becomes seriously ill, the carrier may cancel the policy the next time it comes up for renewal.
Further complicating manners, some states are mandating certain health-care benefits so that if an employer offers a plan at all, it has to include certain types of coverage. Employers who can't afford to comply often have to cut out insurance altogether. The good news: Many states are tying to ease the burden by passing laws that make it easier for small businesses to get health insurance and that prohibit insurance carriers from discriminating against small firms. (MSAs, described above, are in part a response to the problems small businesses face.) The following states make some special provision concerning small employers and health insurance: California, Connecticut, Illinois, Iowa, Kansas, Maine, Massachusetts, New Jersey, North Carolina, Oregon, South Carolina, Tennessee, Wisconsin and Wyoming.
Until more laws are passed, what can a small business do? There are ways to cut costs without cutting into your employees' insurance plan. A growing number of small businesses band together with other entrepreneurs to enjoy economies of scale and gain more clout with insurance carriers.
Many trade associations offer health insurance plans for small-business owners and their employees at lower rates. Your business may have only five employees, but united with the other, say, 9,000 association members and their 65,000 employees, you have substantial clout. The carrier issues a policy to the whole association; your business's coverage cannot be terminated unless the carrier cancels the entire association.
Associations are able to negotiate lower rates and improved coverage because the carrier doesn't want to lose such a big chunk of business. This way, even the smallest one-person company can choose from the same menu of health-care options that big companies enjoy.
Associations aren't the only route to take. In some states, business owners or groups have set up health-insurance networks among businesses that have nothing in common but their size and their location. Check with your local chamber of commerce to find out about such programs in your area.
Some people have been ripped off by unscrupulous organizations supposedly peddling "group" insurance plans at prices 20 to 40 percent below the going rate. The problem: These plans don't pay all policyholders' claims because they're not backed by sufficient cash reserves. Such plans often have lofty-sounding names that suggest a larger association of smaller employees.
How to protect yourself from a scam? Here are some tips:
- Compare prices. If it sounds too good to be true, it probably is. Ask for references from other companies that have bought from the plan. How quick was the insurer in paying claims? How long has the reference dealt with the insurer? If it's less than a few months, that's not a good sign.
- Check the plan's underwriter. The underwriter is the actual insurer. Many scam plans claim to be administrators for underwriters that really have nothing to do with them. Call the underwriter's headquarters and the insurance department of the state in which it's registered to see if it' really affiliated with the plan. To check the underwriter's integrity, ask you state's department for its "A.M. Best" rating, which grades companies according to their ability to pay claims. Also ask for its "claim-paying ability rating", which is monitored by services like Standard and Poor's. If the company is too new to be rated, be wary.
- Make sure the company follows state regulations. Does the company claim it's exempt? Check with your state's insurance department .
- Ask the agent or administrator to show you what his or her commission, advance or administrative cost structure is. Overly generous commissions can be a tip-off; some scam operations pay agents up to 500 percent commission.
- Get help. Ask other business owners if they've dealt with the company. Contact the Better Business Bureau to see if there are any outstanding complaints. If you think you're dealing with a questionable company, contact your state insurance department or your nearest Labor Department Office of Investigations.
Above and Beyond
What does COBRA mean to you? No, it's not a poisonous snake coming back to bite you in the butt. The Consolidated Omnibus Reconciliation Act (COBRA) extends health-insurance coverage to employees and dependents beyond the point at which such coverage traditionally ceases.
COBRA allows a former employee after he or she has quit or been terminated (except for gross misconduct) the right to continued coverage under you group health for up to 18 months. Employee's spouses can obtain COBRA coverage for up to 36 months after divorce or death of the employee, and children can receive up to 36 months of coverage when they reach the age at which they are no longer classified as dependents under the group health plan.
The good news: Giving COBRA benefits shouldn't cost you company a penny. Employers are permitted by law to charge recipients 102 percent of the cost of extending the benefits (the extra two percent covers administrative costs).
The federal COBRA plan applies to all companies with more than 20 employees. However, many states have similar laws that pertain to much smaller companies, so even if your company is exempt for federal insurance laws, you may still have to extend benefits under certain circumstances. Contact the U.S. Department of Labor to determine whether your company must offer COBRA or similar benefits, and the rules for doing so.
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.
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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