One of the greatest benefits you can provide to your staff is a retirement plan. Retirement plans provide benefit to the employee as well as the employer. Retirement plans allow you to invest now for financial security when you and your employees retire. As a bonus, you and your employees get significant tax advantages and other incentives.
Employer contributions are tax-deductible. Assets in the plan grow tax-free. Flexible plan options are available. Tax credits (small employer) and other incentives for starting a plan may reduce costs. A retirement plan can attract and retain better employees, reducing new employee training costs.
Employee contributions can reduce current taxable income. Contributions and investment gains are not taxed until distributed. Contributions are easy to make through payroll deductions. Compounding interest over time allows small regular contributions to grow to significant retirement savings. Retirement assets can be carried from one employer to another. Saver's Credit is available up to $2000 for married couples. The employee has an opportunity to improve financial security in retirement.
Individual Retirement Arrangements (IRAs)
You can contribute if you (or your spouse if filing jointly) have taxable compensation but not after you are age 70½ or older. The most you can contribute to all of your traditional IRA in 2013 is the smaller of, $5,500, or $6,500 if you're age 50 or older by the end of the year, or your taxable compensation for the year. Your contribution must be made by your tax return filing deadline (not including extensions). For example, you have until April 15, 2014, to make your 2013 contribution. You must start taking required minimum distributions by April 1 following the year in which you turn age 70½ and by December 31 of later years. Any deductible contributions and earnings you withdraw or that are distributed from your traditional IRA are taxable as ordinary income. However, it's still a great deal considering the net present value of that tax you pay in 30 years is significantly less (~90% less) than if you were to pay the tax on that income today. Please note that if you are under age 59 ½ you may have to pay an additional 10% tax penalty for early withdrawals unless you qualify for an exception. You cannot take a long term loan against your IRA account.
You can contribute at any age if you (or your spouse if filing jointly) have taxable compensation and your modified adjusted gross income is below certain amounts. Your contributions aren't deductible, but your investment earnings grow tax free. The contribution limits and filing deadlines are the same as the traditional IRA. You are not required to take required minimum distributions. Qualified distributions (made after the 5 year tax year period) are not taxable. Otherwise, part of the distribution or withdrawal may be taxable. If you are under age 59 ½, you may also have to pay an additional 10% tax penalty for early withdrawals unless you qualify for an exception. You cannot take a long term loan against your IRA account.
A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts. Elective salary deferrals are excluded from the employee's taxable income (except for designated Roth deferrals). Employers can contribute to employees' accounts. Distributions, including earnings, are includible in taxable income at retirement (except for qualified distributions of designated Roth accounts). There is a limit on the amount of elective deferrals that you can contribute to your traditional or safe harbor 401(k) plan is $17,500 for 2013. You can take a loan against your 401(k) up to $50,000 or 50% of vested account balance, whichever is less. The elective deferral/catch up contribution age 50 and older limit increases to $5,500 for 2013.
There are other limits that restrict contributions made on your behalf. In addition to the limit on elective deferrals, annual contributions to all of your accounts - this includes elective deferrals, employee contributions, employer matching and discretionary contributions and allocations of forfeitures to your accounts - may not exceed the lesser of 100% of your compensation $51,000 for 2013. In addition, the amount of your compensation that can be taken into account when determining employer and employee contributions is limited. The compensation limitation is $255,000 for 2013. Although contributions are not treated as current income for federal income tax purposes, they are included as wages subject to social security (FICA), Medicare, and federal unemployment taxes (FUTA) or by most State governments until they are distributed. A 401(k) plan may allow participants to take their benefits with them when they leave the company, easing administrative responsibilities.
- Traditional 401(k) plans plan allow eligible employees (i.e., employees eligible to participate in the plan) to make pre-tax elective deferrals through payroll deductions. In addition, in a traditional 401(k) plan, employers have the option of making contributions on behalf of all participants, making matching contributions based on employees' elective deferrals, or both. These employer contributions can be subject to a vesting schedule which provides that an employee's right to employer contributions becomes non-forfeitable only after a period of time, or be immediately vested. Rules relating to traditional 401(k) plans require that contributions made under the plan meet specific nondiscrimination requirements. In order to ensure that the plan satisfies these requirements, the employer must perform annual tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, to verify that deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees.
- Safe harbor 401(k) plans. A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals. The safe harbor 401(k) plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401(k) plans.
- SIMPLE 401(k) plans. The SIMPLE 401(k) plan was created so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to traditional 401(k) plans. As with a safe harbor 401(k) plan, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. Limits on the amount of elective deferrals that a plan participant can contribute to a SIMPLE 401(k) plan are different from those in a traditional or safe harbor 401(k). The limit is $12,000 in 2013. The catch up contribution is $2500 in 2013. Employees who are eligible to participate in a SIMPLE 401(k) plan may not receive any contributions or benefit accruals under any other plans of the employer.
403(b) Plans - A tax-sheltered annuity (TSA) plan is a retirement plan, similar to a 401(k) plan, offered by public schools and certain 501(c)(3) tax-exempt organizations. An individual may only obtain a 403(b) annuity under an employer's TSA plan.
SIMPLE IRA Plans (Savings Incentive Match Plans for Employees)
A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan. They are available to any small business - generally with 100 or fewer employees. Easily established by adopting Form 5304-SIMPLE, 5305-SIMPLE, a SIMPLE IRA prototype or an individually designed plan document. Employers cannot have any other retirement plan. There is no filing requirement for the employer. The employer is required to contribute each year either a: Matching contribution up to 3% of compensation, or 2% non-elective contribution for each eligible employee. Employees may elect to contribute. Employee is always 100% vested in all SIMPLE IRA money. The amount the employee contributes to a SIMPLE IRA cannot exceed $12,000 in 2013. The catch-up contribution limit for SIMPLE IRA plans for 2012 and 2013 is $2,500. These plans are relatively easy and inexpensive to set up and operate. The employees share responsibility for their retirement. There is no discrimination testing required. Although, they have Inflexible contributions and lower contribution limits than some other retirement plans
SEP Plans (Simplified Employee Pension)
A SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP. The Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee's pay. It is available to any size business. It is easily established by adopting Form 5305-SEP, a SEP prototype or an individually designed plan document. If Form 5305-SEP is used, the business cannot have any other retirement plan (except another SEP). There is no filing requirement for the employer. Only the employer contributes. Employee is always 100% vested in (or, has ownership of) all SEP-IRA money. They are easy to set up and operate and have low administrative costs. They also have flexible annual contributions - good plan if cash flow is an issue. However, employer must contribute equally for all eligible employees and SEP's do not provide for participant loans.
A SARSEP is a Simplified Employee Pension (SEP) plan that was established before 1997. Permits employee salary reduction contributions. Meets the following participation requirements annually based on all eligible employees (even those hired after 1996): At least 50% of eligible employees must choose to make employee salary reduction contributions for the year. Had no more than 25 employees who were eligible to participate at any time during the preceding year.
Payroll Deduction IRAs
Under a Payroll Deduction IRA, employees establish an IRA (either a Traditional or Roth IRA) with a financial institution and authorize a payroll deduction amount for it. A business of any size, even self-employed, can establish a Payroll Deduction IRA program. Payroll Deduction IRAs have the same limits as other IRAs.
Contributions to a profit-sharing plan are made by the employer only and are discretionary. There is no set amount that you need to make. If you can afford to make some amount of contributions to the plan, then go ahead. If you do make contributions, you will need to have a set formula for determining how the contributions are divided. This money goes into a separate account for each employee. If you establish a profit-sharing plan, you can have other retirement plans. You can be a business of any size. However you are required to annually file a Form 5500. This plan offers greater flexibility in contributions as contributions are strictly discretionary. It is a good plan if cash flow is an issue. However, administrative costs may be higher than under more basic arrangements. You will also need to test that benefits do not discriminate in favor of the highly compensated employees. Contribution Limits: The lesser of 25% of compensation $51,000 for 2013. Participant Loans are permitted under this plan.
Defined Benefit Plans
Employers can generally contribute (and, therefore, deduct) more than to other types of plans. Substantial benefits can be provided - even with early retirement. Vesting can be immediate or spread out over a seven-year period. Benefits are not dependent on asset returns. If you establish a defined benefit plan you: can have other retirement plans, can be a business of any size, need to annually file a Form 5500 with a Schedule B, need to have an enrolled actuary determine the funding levels and benefits cannot be retroactively decreased. Significant benefits are possible in a relatively short period of time. Employers can contribute (and deduct) more than under other retirement plans. Deduction limit is any amount up to the plan's unfunded current liability (see an enrolled actuary for further details). These plans provide a predictable benefit. They can be used to promote certain business strategies by offering subsidized early retirement benefits. However, these are the most costly type of plan and are the most administratively complex. An excise tax applies if the minimum contribution requirement is not satisfied.
Money Purchase Plans
Money purchase plans have required contributions. Employers are required to make a contribution, on behalf of the plan participants, to the plan each year. Employees may also contribute to these plans. With a money purchase plan, the plan states the contribution percentage that is required. For example, let's say that your money purchase plan has a contribution of 5% of each eligible employee's pay. You, as the employer, need to make a contribution of 5% of each eligible employee's pay to their separate account. A participant's benefit is based on the amount of contributions to their account and the gains or losses associated with the account at the time of retirement. It is possible to grow larger account balances than under some other arrangements. However, administrative costs may be higher than under more basic arrangements. You are required to test that benefits do not discriminate in favor of the highly compensated employees. An excise tax applies if the minimum contribution requirement is not satisfied. Contributions are limited to the lesser of 25% of compensation or $51,000 in 2013. Annual filing of Form 5500 is required. Participant Loans are permitted.
Employee Stock Ownership Plans (ESOPs)
An employee stock ownership plan (ESOP) is an IRC section 401(a) qualified defined contribution plan that is a stock bonus plan or a stock bonus/ money purchase plan. An ESOP must be designed to invest primarily in qualifying employer securities as defined by IRC section 4975(e)(8) and meet certain requirements of the Code and regulations. The IRS and Department of Labor share jurisdiction over some ESOP features.
One of the greatest benefits you can provide to your staff is a retirement plan. Retirement plans provide benefit to the employee as well as the employer. Retirement plans allow you to invest now for financial security when you and your employees retire. As a bonus, you and your employees get significant tax advantages and other incentives. Retirement plans can help you attract and retain better employees, this can help you improve company performance and reduce new employee training costs.
If you questions regarding retirement plans or any other tax planning strategies, please give us a call!
Paul J. Beckert MBA, CPA
Pinnacle Business Solutions
Note: The information contained in this material represents a general overview of tax regulations and should not be relied upon without an independent, professional analysis of how any of these provisions apply to a specific situation.