Which Retirement Plan Fits Best?

You want to make sure that your company's retirement plan accomplishes the goals you have for it. But selecting the right plan isn't always easy. There are a number of options to choose from, including 401(k), SEP (Simplified Employee Pension), SIMPLE (Savings Incentive Math Plan for Employees), and profit sharing plans, among others. The following is some general information about how these plans operate that may be useful to employers who are considering changing plans or adding a plan.

With a 401(k) plan, employees may elect to defer a portion of their salary on a pretax basis into the plan. For 2017, employees may contribute up to $18,000 (or up to $24,000 with catch-up contributions). Employers may also choose to make additional contributions, including matching contributions, to employee accounts. For 2017, combined employer and employee contributions may not exceed the lesser of 100% of compensation or $54,000.

Employee contributions are immediately 100% vested, while employer contributions may vest over time according to the terms of the plan document. Contributions, as well as any earnings thereon, are generally not subject to federal income taxes until distributed. A 401(k) plan may also offer employees the option of making after-tax Roth contributions. Qualified distributions from a designated Roth account are excluded from income.

Plans may allow participants to take loans and/or hardship withdrawals from their accounts. However, such options may add to the sponsor’s administrative burdens. Other obligations include annual reporting and, generally, annual testing to verify that the plan does not discriminate in favor of highly compensated employees. As a result, administrative costs may be higher than for other types of plans.

To set up a SEP plan, an employer establishes individual retirement accounts (IRAs) for its employees. Contributions are made by the employer only. The employer has discretion in determining whether or not to make an annual contribution. Qualifying contributions are tax deductible (within limits) and are not included in the employees’ current income. Taxes are deferred until money is withdrawn from the plan.  

Contributions per employee cannot exceed the lesser of 25% of each employee’s compensation or $54,000, and no more than $270,000 of compensation may be considered (for 2017). Although contribution percentages generally must be equal for all eligible employees, they can vary on an annual basis. Contributions are deductible by the employer up to 25% of compensation paid to participating employees (subject to the $270,000 compensation limit).

SEP plans are easy to set up and administer. They generally have neither the start-up or operating costs of a conventional retirement plan nor the annual filing requirements. Because an employer can choose not to contribute at all, a SEP plan may be suitable if your cash flow varies from year to year.

SIMPLE plans are available to businesses with 100 or fewer employees who received at least $5,000 of compensation from the employer for the preceding year and that don’t have another employer-sponsored retirement plan (except, under certain circumstances, a collectively bargained plan). SIMPLE plans can be structured as a SIMPLE 401(k) plan or a SIMPLE IRA plan. Although there are generally no annual filing requirements for a SIMPLE IRA plan, employers must annually file a Form 5500 if using a SIMPLE 401(k) plan.

SIMPLE plans generally offer the benefits of less administrative complexity with the opportunity for employees to make elective deferrals. For 2017, employees may make elective deferrals of up to $12,500, plus another $3,000 for those 50 and older.

For both SIMPLE 401(k) and SIMPLE IRA plans, the employer must make either a matching contribution of up to 3% of each eligible employee’s compensation or a nonelective contribution of 2% of each eligible employee’s compensation. The employer’s nonelective contributions must be made even if the employee does not make any contributions during the calendar year. 

Profit Sharing
Profit sharing plans are a good way to encourage employees to have a sense of ownership in the company and to let them share in its success. With a stand-alone profit sharing plan, only the employer makes contributions, which are limited to the lesser of 25% of allowable compensation (subject to a $270,000 limit for 2017) or $54,000. There are no size restrictions on companies offering this type of plan. A profit sharing plan may include a 401(k) arrangement.

Since contributions generally are discretionary, profit sharing plans may meet the needs of companies that have irregular cash flows. Your company does not need to have a profit to make contributions, and you are not required to make a contribution in any given year. However, contributions to a profit sharing plan must be “recurring and substantial” for the plan to be considered ongoing. 

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