Retirement Savings Plans For Self Employed - Help Small Businesses Choose the Right Employee Retirement Plans CPAs can help business owners understand the different options available. Jimmy J. By Williams, CPA/PFS
Retirement plans offer small business owners significant tax advantages and give them and their employees an incentive to save for the future. There are many types of retirement plans available for small businesses, each with their own requirements and restrictions. The same plan is not necessarily ideal for companies of all sizes and ownership structures, so small business owners need to do their homework before making a decision.
Retirement Savings Plans For Self Employed
As a CPA, you can help business owners choose and implement the plan that works best for them. You can base your recommendations on the unique characteristics of your client's business, such as the owner's retirement goals, how the business is set up (as a sole proprietorship, a limited liability company, a C corporation, or an S corporation). No. of employees, and so on. You can also help them understand the legal and compliance issues associated with each type of plan, as well as any tax benefits that may come with it.
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What follows is an overview of plan types, as well as a discussion of issues to consider when assisting small business clients through the often confusing process of choosing a retirement plan.
There are different types of retirement plans available to small business owners. Major ones include the following (see the chart, "Comparison of Retirement Plans for Small Businesses," for more details on the four most common types of plans):
SEPs can be used by businesses with any number of employees. Contributions are made only by the employer (the lesser of 25% of each qualified employee's compensation or up to $55,000 for 2018) and are tax-deductible as a business expense. The main advantage of SEP plans is how easy they are to manage. After adoption, SEPs typically require no annual IRS form filings, and administrative costs are minimal.
There are three steps to setting up a SEP. The employer must (1) enter into a written agreement to provide benefits to all eligible employees; (2) give employees certain information about the agreement; and (3) establish an IRA account for each employee. The IRS has a model SEP plan document, Form 5305-SEP, Simple Employee Pension - Individual Retirement Account Contribution Agreement. However, not all employers may use Form 5305-SEP, and some must use a prototype document instead.
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However, SEPs do not allow employees to defer income, and employees are always 100% invested in employee contributions to their SEPs. Therefore, they may not be the best choice for companies in industries with high employee turnover or that want to use a retirement plan to retain employees. Another potential drawback to these plans is that they require the employer to contribute the same percentage for all eligible employees. Because of this requirement, a small business with a self-employed owner may lack sufficient cash flow to support such a plan if the owner wishes to make large contributions to his or her SEP.
Simple IRAs are generally available to businesses with 100 or fewer employees who received $5,000 or more in compensation in the previous year. These plans are funded by tax-deductible employer contributions and pretax employee contributions.
As the name implies, simple IRAs are simple to set up and manage. The employer may use Form 5304-Simple, Savings Incentive Match Plan (Simple) for Employees of Small Employers - Not for Use with a Designated Financial Institution, or Form 5305-Simple for Employees of Small Employers, to implement the plan. Plan. (Standard) - For use with a designated financial institution. As with Form 5305-SEP, the employer is required to keep the form in its records but not file it with the IRS.
A small employer may want to implement a SIMPLE IRA plan because it allows employees to defer income by making salary reduction contributions (subject to annual limits) to their SIMPLE IRA. Another potential advantage for the employer of a SIMPLE IRA plan over a SEP is that it generally requires a smaller contribution from the employer. An employer must match each employee's payroll deduction contribution dollar-for-dollar up to 3% of the employee's compensation or make a non-elective contribution of 2% of an eligible employee's compensation (up to $275,000 for 2018). Contributes to the reduction of wages.
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As with SEPs, however, employees are always 100% invested in employee contributions to SIMPLE IRAs, so they may not be the best choice for companies in high-turnover industries.
Qualified plans are more complex than SEPs or Simple IRAs and, therefore, have stricter reporting requirements. But they may be more appropriate for larger or growing businesses. Larger businesses typically have the staff and infrastructure to accommodate the reporting required of a qualified plan and, in particular, the qualified plans desire features such as allowable loan provisions and in-service withdrawals. There are several types of eligible plans, which can be divided into two broad categories: defined benefit and defined contribution plans.
Defined Benefit Plans. Commonly known as pension plans, defined benefit plans promise to pay employees a fixed income stream at some point in the future. The amount each employee receives is generally based on earnings history and length of service. Employers must contribute enough to a defined benefit plan each year to satisfy what is known as the minimum funding requirement. Because of the complexity of minimum funding calculations and other requirements, managing a defined benefit plan typically requires professional help from an actuary. For this reason, very few small businesses use them.
Defined Contribution Plans. With defined contribution plans, employers contribute to individual accounts for each employee. Employees generally have the right to invest money as they see fit in the investment options provided by the scheme. Defined contribution plans do not require immediate investment of amounts contributed to the plan by employers and may allow employee loans.
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Types of defined contribution plans include profit sharing plans and money purchase plans. Under a profit sharing plan, an employer's contributions are discretionary, so the employer is not required to contribute to the plan each year. Under a money purchase plan, contributions are mandatory, so the employer must contribute to the plan each year, and the contribution percentage used to determine the contribution amount cannot vary from year to year.
Benefit sharing plans may include a 401(k) feature (also known as a cash or deferred arrangement, or CODA) whereby employees participating in the plan receive a portion of their pretax compensation instead of individuals may choose to contribute to the account. Compensation in cash. These contributions are called "elective deferrals" because the employee elects to defer receipt of the amount contributed to the account. A profit-sharing plan with a 401(k) feature is called a "401(k) plan." A "solo 401(k) plan" is a 401(k) plan that covers only a business owner and his or her spouse.
For 2018, participants in a 401(k) plan can make elective deferrals of up to $18,500 ($24,500 for participants age 50 or older at the end of the calendar year). If the plan allows, employers can contribute a percentage of each employee's compensation to the employee's account (a non-elective contribution) or, within certain limits, match the amount of the employee's elective deferrals, or both. Total employee and employee contributions to a 401(k) plan are limited to the lesser of:
A 401(k) plan can be designed so that employee ownership in employee matching or non-elective contributions vests over time, under a vesting plan. After the vesting period for a contribution is complete, the employee is 100% vested in the employer's contributions and has a non-enforceable right to the full amount of the contributions in his account. Providing for the vesting of employee contributions to a retirement plan can help an employer retain valuable employees.
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Under a graded vesting plan, an employee vests in increasing employer contributions over a period of years. Many plans use a five-year vesting plan, with 20% of the employee vesting in contributions per year of service, with the employee vesting 100% in contributions at the beginning of year 6. For example, an employer's plan document includes a five- Year vesting plan for employees matching and non-elective contributions to employee accounts as a plan provision. The employer makes an employee matching contribution in the amount of $10,000 to an employee's retirement account in year 1. Should the employee decide to leave the company during his second year of service, he will be entitled to keep $ 2,000, or so. 20% of the employer's contribution.
Alternatively, some plans provide "rock vesting". With cliff vesting, the employee vests in all employer contributions after the employee completes a specified minimum number of years of service. This vesting method reduces the amount of employee contributions retained by high-turnover employees
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