As your business grows and you add staff, picking the right retirement plan becomes more complicated. You have a wider selection of plans to choose from, including not only a simplified employee pension plan (SEP) for single-person companies, but also profit-sharing and money-purchase plans, defined-benefit programs and 401(k)s.
That variety, though, also gives you a better chance of choosing a plan that more precisely meets your needs-beefing up savings for key executives, say, or providing an incentive for employees to work harder.
Here is a range of available plans-most of them sold ready-made by financial service companies-and a description of how each can help solve a different set of business problems. The plans are usually suitable for companies with no more than about 25 workers.
The following is a rundown of retirement-plan options, with the simplest ones first:
– SEPs. After creating and marketing movie posters for 10 years, $1.7-million-a-year T.I.R. & Associates in Los Angeles finally turned a $50,000 profit in 1993. Tony Lane-Roberts, the company’s president, wanted to shield the money from taxes-and help himself, his wife (the firm’s controller) and their nine employees prepare for retirement. But he insisted that the plan be simple to establish, inexpensive to operate and allow him to vary future contributions according to profits.
His choice-a SEP-fulfills all those objectives. To open it at a local bank, Lane-Roberts simply filled out a one-page form that set up tax-deferred accounts in his and his employees’ names. Each year, he can contribute to the accounts an amount equal to as much as 15 percent of each employee’s salary-the percentage must be the same for all-up to a maximum of $22,500 per person. (In lean years, he can forgo making any deposit.)
The company gets a tax deduction for the contributions, and the money grows tax deferred until the employee withdraws it. (Anyone who does so before age 59 1/2 will owe a 10 percent tax penalty in addition to regular taxes.)
While SEPs are cheap and easy to operate, you can’t use them unless you’re willing to cover all employees who have worked for you for at least three of the past five years and earned $400 or more in the current year. Thus you may have to contribute for part-timers. Furthermore, SEPs don’t allow vesting, which is a requirement that employees stay with you for as long as seven years before they can take full possession of their accounts.
– SARSEPs. A salary-reduction SEP (SARSEP) operates much like a SEP, except that the employees-not the firm-make the contributions. Each worker chooses how much he or she wants to set aside through regular payroll deductions (of pretax dollars) up to a maximum of 15 percent of salary or $9,240 a year, whichever is less.
SARSEPs are available only to firms with 25 or fewer workers, and 50 percent of all eligible employees must participate. In addition, no more than 60 percent of contributions can be made by highly compensated employees (sometimes defined as those making more than $75,000). If the company fails the latter test, called the top-heavy rule, the IRS will require it to put its own cash into employees’ accounts-a minimum of 3 percent of salary.
– 401(k) plans. To give employees a heftier incentive to save for retirement, you might consider a 401(k). It resembles a SARSEP in that employees put in their own pretax money up to the $9,240 annual limit. In addition, to encourage them to contribute-and thus satisfy the top-heavy rule-your company can match some or all of their contributions, so long as the annual total for each person doesn’t exceed 25 percent of salary or $30,000.
To encourage employees to leave their money in the plan until retirement, you can offer them the option of borrowing against their accounts.
– Profit-sharing plans. Virtually all 401(k)s, SEPs and SARSEPs make employees responsible for investing their own money. But some owners prefer to turn the job over to professionals instead. They can do so because their plans are profit-sharing plans.
Superficially, such a plan resembles a SEP, in that the company-not the employee-puts up the money, which normally can be as much as 15 percent of salary or $22,500 a year. But a profit-sharing plan gives you greater flexibility and control than a SEP. You can require vesting, exclude workers who quit during their first year, and either control the investments yourself or hire a pro to do so.
You can also set up so-called age-weighted or title-weighted plans; they let you set aside up to 25 percent of salary or $30,000 a year for people over a certain age or rank.
If you want to make annual contributions that are not tied to profits, you can institute a money-purchase plan. It operates just like a profit-sharing program, except that you must put in the same percentage of employees’ salaries every year, up to 25 percent, or $30,000, whichever is less.
To give themselves a little more flexibility, some owners open both a money-purchase and a profit-sharing plan. They contribute a steady 10 percent to the money-purchase plan every year, regardless of profits. When their business does well, they add as much as another 15 percent to the profit-sharing plan-thus bringing the total contribution up to the 25 percent maximum that the IRS permits.
– Defined-benefit plans. A better, although more complicated, way to raise your company’s retirement contribution is by setting up a classic pension program known as a defined-benefit plan. Its advantage over most other options: Retirees’ pensions are based on an actuarial formula that takes into account their age, salary and life expectancy. The maximum payout is $118,800 a year. Once the target is set, the plan basically lets you set aside as much money as you need each year to meet that goal.
Setting up and operating a defined-benefit pension isn’t a snap, though. Its paperwork makes other plans look like kindergarten projects. In general, stick with simpler plans unless you have key employees over age 50 who need to bulk up their retirement savings fast.
