There are several compelling reasons why you should have a retirement plan for your business. It helps you and your employees save for retirement on a tax-advantaged basis. Owners should not assume that their business alone is their retirement nest egg because businesses may not be as valuable in the future as hoped for. Having a retirement plan allows for deductions and tax credits for the business. And a retirement plan is an important fringe benefit to attract and retain valued employees, a consideration paramount in this tight labor market.
Qualified retirement plan options
A qualified retirement plan is a type of savings plan under federal rules. Some plans are funded solely by employers, some by employees, and some by both. Options include:
- IRA-based plans, such as payroll deduction IRAs, SEPs, and SIMPLE-IRAs
- Defined contribution plans, such as profit-sharing, safe harbor 401(k), automatic enrollment 401(k), and traditional 401(k)
- Defined benefit plans, which are pension plans providing a fixed retirement benefit not dependent on investment performance
Find more information to help you make a choice in IRS Publication 3998, Choosing a Retirement Solution for Your Small Business. This pamphlet has a side-by-side comparison of plan options as well as an explanation of what each plan involves.
Tax considerations
Employer contributions on behalf of employees are tax deductible. Employees are not taxed on employer contributions; these amounts are exempt from payroll taxes.
Employee contributions generally are made on a pre-tax basis (i.e., employees aren’t taxed on the amount of their compensation put into the plan). However, contributions to 401(k) plans are still treated as “wages” for purposes of FICA. And 401(k) plans may offer a designated Roth option in which employees make after-tax contributions with the view toward creating tax-free retirement income; compensation added to designated Roth accounts are taxable.
Employers in small businesses who do not currently have retirement plans may be eligible for a tax credit of up to $5,000 per year for up to 3 years for setting up a plan. This helps defray the cost of administration and employee education about the plan. To claim the credit, the plan must cover at least one employee who is not an owner or spouse. Pending legislation—SECURE Act 2.0—would increase the credit amount after 2021.
Employers in small businesses that adopt an automatic enrollment plan, such as a 401(k) to which employees contribution a set amount unless they opt out, may claim a credit up to $500 for up to 3 years. This credit applies whether the plan is new or is an older plan that switches to automatic enrollment. This credit can be claimed in addition to the start-up credit.
State programs
A number of states, including California, Colorado, Connecticut, Illinois, Maine, Maryland, New York (signed into law on October 21, 2021), Oregon, and Virginia, have a state Secure Choice Program. It requires employers without a qualified retirement plan to enroll eligible employees into the state program. Employers don’t contribute; they merely set up a payroll deduction arrangement to funnel employee contributions. Employers must give notice to these employees so they can opt out or reduce the automatic salary contribution.
In deciding whether to implement a qualified retirement plan, use the state’s Secure Choice Program if available, or do nothing, determine:
- Are you in a state with a Secure Choice Savings Program? If not, can you really afford to forego having a qualified retirement plan for you and your staff?
- If yes, are you subject to its mandate? It depends on the number of employees. In New York, for example, it means having at least 10 employees in the prior year. It may also depend on other factors. In New York, the mandate only applies to companies in business for at least 2 years.
Final thoughts
George Foreman said: “The question isn’t at what age I want to retire, it’s at what income.”
Without a retirement plan, it’s difficult for most small business owners and their employees to contemplate a secure financial future. While employers technically have until the due date of their return to set up and fund a plan, notice requirements to employees for certain plans mean action is needed now for 2022 plans. Work with a CPA, benefits plan advisor, or other tax pro to find the best retirement plan solution for your situation.
