Retirement Plans for Small and Independent Businesses — Should You Offer One? And If So, Which One?
An independently-owned business may want to offer a retirement plan to its employees for a variety of reasons, which may include: incentivizing talent to accept a job offer, encouraging employees to stay with the firm, providing tax benefits to the firm, or enacting internal firm values and principles.
Planning for retirement is a critical part of life planning, but with only half of Americans between the ages of 18 and 34 actually saving for retirement, offering a retirement plan for all your employees can also be a tool for education and empowerment, ensuring that your colleagues are set up for a more secure financial future.
In addition to talent acquisition and retention benefits, offering a retirement plan for your employees can provide financial advantages both for you and your employees. Some retirement plans allow for pre-tax contributions, which means that the initial investment principal is greater than if employees were to simply set aside some of their own income into an investment portfolio after income tax and other taxes are applied. With that larger initial investment, gains over time will be greater than if only after-tax dollars were invested. Contributions to employee retirement plans can also have some advantages for employers, providing tax deductions to the firm.
So which retirement plan should you offer to employees of your small business?
The team at More Canvas Consulting was recently asked by a client, “How should I approach providing retirement benefits for employees in order to attract and keep quality talent?”
To provide an actionable, data-driven recommendation, we went into research mode and are happy to share our findings below in a full-length, easy-to-follow text with links for further reading, complimented by a graphic that provides a side-by-side comparison of retirement plans.
RETIREMENT PLAN OPTIONS FOR SMALL BUSINESSES: Simple IRA, SEP IRA, 401(k)
What is a Simple IRA?
A SIMPLE IRA is a retirement plan that can be offered by companies with 100 employees or fewer, which do not already offer a retirement plan. In order to be eligible to contribute to a SIMPLE IRA account, an employee must have earned at least $5,000 during any two prior years and expect to earn at least $5,000 in the current year. If desired, employers can make these requirements less restrictive. With a SIMPLE IRA, the employer has some choice on how the plan is structured.
In SIMPLE IRAs, the employer is required to contribute to the account, while the employee has the option to contribute or not. The employer, however, is required to contribute either a dollar-for-dollar match of employee contributions (up to 3% of the employee’s salary) or contribute 2% of the employee’s salary. An employer must decide whether or not to require matching from the employee. If the employer does not require matching contributions from the employee, a 2% contribution of the employee’s salary must be made by the employer.
Each year, the employer must also determine which contribution structure to follow, and then offer it to each employee who chooses to participate. Standard penalties apply for early withdrawal, and no loans can be taken against a SIMPLE IRA account. The employer is required to make certain employee notifications, though the business is not required to file with the IRS for this plan. As a perk for both sides: for employers, contributions are a deductible business expense, and for employees, earnings are tax-deferred (the contributions are pre-tax). Account fees vary depending on the provider of the retirement plan. The employee is always 100% vested in all SIMPLE-IRA money.
What is a SEP IRA?
A SEP IRA (Simplified Employee Pension Plan) is a retirement plan that can be offered by self-employed individuals to themselves, or any business that does not already have a retirement plan in place for its employees. In general, employees must be 21 or older, have worked for the same employer for at least three of the past five years, and earn a minimum amount (varies, depending on the tax year), in order to participate. (Though, employers have the option to make the requirements less restrictive.) Within a SEP IRA, contributions must be made by an employer and can range from 0% to 25% in any given year. Each employee who is part of the plan must receive the same percentage (with a maximum contribution depending on the tax year). Employees are not allowed to make contributions to the plan through payroll deductions, but they can make traditional IRA contributions to the plan. Standard fees apply to early withdrawals. Employers are required to fill out and keep a Form 5305 SEP in their records, but do not have to file taxes for the plan with the IRS. Earnings are tax-deferred, and contributions are tax-deductible. Account fees vary depending on the provider of the retirement plan. The employee is always 100% vested in all SEP-IRA money.
What is an Individual 401(k)?
An Individual 401(k) is a retirement plan designed for businesses with only one employee (independent contractors do not count), in which that individual is able to maximize contributions by contributing both as employer and employee. Contributions are not required every year under this plan. Individual 401(k)s can be either pre-taxed or after-taxed. The individual can contribute up to 25% of their salary (as the employee) and can contribute elective deferrals of up to 100% (as the employer), with the maximum contribution depending on the tax year. Pre-tax contributions are deductible. Standard fees apply to early withdrawal. Generally, an annual report on Form 5500-EZ to the IRS is required (though may be exempt if assets do not exceed $250,000).
Sources: Vanguard, Fidelity: SIMPLE, Fidelity: SEP, Fidelity: Individual 401(k), IRS: SIMPLE, IRS: SEP, IRS: Individual 401(k)
OTHER TYPES OF RETIREMENT ACCOUNTS: ROTH IRA, Traditional IRA, 401(k)
Traditional IRA
A traditional IRA is another retirement plan companies are able to offer to their employees. It is an investment vehicle through which tax-deductible contributions can be made into tax-deferred earnings. The amount that an employee contributes to their traditional IRA cannot exceed their income earned in a given year, and cannot exceed a certain amount that is dependent on their age (below vs above 50 years old) and the given tax year. Early withdrawals from a traditional IRA are subject to standard penalties. As a part of a traditional IRA, there is a required minimum distribution rule, requiring participants to withdraw a certain minimum amount each year after the age of 72. An employer can contribute to an employee’s traditional IRA, but is not required to. Additionally, not all traditional IRAs are through an employer, rather, in many cases, individuals go straight to the IRA provider/manager (in which case there is no contribution from the employer).
Roth IRA
A Roth IRA is similar to a traditional IRA in that they are both retirement plans that can be offered either through an employer or not. The main difference between the two is that a Roth IRA consists of post-tax contributions, and the gains are not taxed when withdrawn after retirement. A Roth IRA has similar maximum contribution rules as a traditional IRA, including standard penalty fees and being subject to taxes for early withdrawal. Unlike with a traditional IRA, a Roth IRA is not affected by the minimum withdrawal rule even after an employee turns 72. Finally, in order for an individual to be eligible to contribute to a Roth IRA, they must be earning below a certain amount per year—this is dependent on marital status and tax year/regulations.
Source: Investopedia: 401(k) vs. Roth IRA.
“But how do I actually provide a retirement plan for my employees? What services can I use?”
Once we determined that a SIMPLE IRA was the ideal small business retirement plan for this particular client, we went a step further to understand, “How do I provide a retirement plan for my employees?” The parameters that we determined were most critical in selecting a SIMPLE IRA provider included:
simplicity and ease of quickly setting up a retirement plan
ease for employees to allocate their portfolios once the plan is established
range of options for employees to allocate their portfolios
fee structure of each provider
the work involved for the employer to maintain the plan on behalf of their employees each year
While there are many platforms and providers you can select to offer your employees a retirement plan, we narrowed the field down to four major investment platform players: Vanguard, Merrill Edge, Charles Schwab, and Fidelity.
Retirement Plan Providers
Vanguard
Vanguard Website | Vanguard Fee Page
Vanguard is one of the world’s largest investment management firms, based in Malvern, Pennsylvania, boasting 19 locations worldwide, with approximately $7 trillion in assets under management. Vanguard offers many different services including: mutual funds, IRSs, ETFs, 401(k) plans, and more. The SIMPLE IRA that Vanguard offers is different from others we researched in that: they charge a $25 annual fee for each Vanguard fund in a SIMPLE IRA; it takes about two weeks for an employer to setup the SIMPLE IRA with Vanguard; and the investment allocation options are limited exclusively to Vanguard Mutual funds.
Merrill Edge
Merrill Edge Website | Merrill Edge Fees Page
Merrill Edge is a trading platform existing under Bank of America with just over $1 trillion in assets under management. It was founded in 2010, when it was created to merge Bank of America’s online trading and Merrill Lynch’s research, investment tools, and customer service center. It offers an online trading platform for individuals, third party research tools, mutual funds, IRAs, and 401(k)s. The SIMPLE IRA that Merrill Edge offers differs from the others that we researched in that it offers one of the widest ranges of options for portfolio allocation to its members. It also has zero fees (with the exception of certain trades, such as options). The process to open and maintain a SIMPLE IRA with Merrill Edge is simple for both employers and employees.
Charles Schwab
Charles Schwab Website | Charles Schwab Fees Page
Charles Schwab is an American financial services company based out of Westlake, Texas, with just under $6.7 trillion in assets under management. It offers many services including: banking, commercial banking, a trading platform, private wealth management services to both retail and institutional clients, and many different types of retirement plans to both businesses and individuals. Charles Schwab’s SIMPLE IRA is middle-ground compared to the other plans researched: It offer plans with zero fees, with the option to allocate investments to mutual funds, stocks, and fixed income securities; like other providers, it offers an online portal for users to allocate funds and check their balances; and its SIMPLE IRA plan is fairly easy to open (though not as simple as some of the others on this list).
Fidelity
Fidelity Website | Fidelity Fees Page
Fidelity is an American financial services company based in Boston, Massachusetts, with $10.4 trillion in assets under management. It offers a range of services including: an online trading platform, a research database, private wealth management, and retirement plans. Fidelity offers a SIMPLE IRA plan that is very straight-forward, with an easy online platform for its users, zero account fees or fees on regular trades, easy maintenance for the employer, and one of the largest variety of portfolio allocation options. One drawback on its plan is that the company requires you to mail in the initial documents, causing the process to take up to two weeks.
In Conclusion
Offering a retirement plan for employees of your small business provides clear benefits, building stability and trust within the firm, while providing tax and monetary incentives to both the firm and the firm’s employees. In the current, tedious job market, this is also one additional layer to help small businesses stand out to new talent. More Canvas is pleased to offer its findings on the types of available retirement plans and an overview of providers (with direct links) above to promote a smooth undertaking for you and your team. If you run into questions along the way, don’t hesitate to reach out to our team.
Links for further reading on retirement and your small business:
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