Choosing a Retirement Plan for Your Business

As a business owner, you want to attract and retain top talent. After all, your people are often on the front lines engaging with your clients. One of the tools you can use to lure the cream of the crop to your team is to offer a great retirement plan.?

You see, choosing the right retirement plan is important to everyone. For business owners, however, this is especially significant. But with so many options, how do you choose the right one? To do that, we must consider tax implications, as well as understand the value that the right plan can offer when it comes to building and retaining the right team.?

Let’s explore the details of some of the most common types of retirement accounts.?

Traditional and Roth IRAs

The traditional Individual Retirement Account (IRA) and Roth IRA are both forms of qualified accounts. They each carry valuable tax benefits with the primary difference being when the tax benefit is available to you. You contribute to a Roth — named after the senator who presented the legislation — with after-tax dollars, meaning you have already paid the taxes upfront. With a traditional IRA, you contribute pre-tax dollars to the account.

As of 2024, if you are under the age of fifty, you can contribute up to $7,000 per year to both the traditional and the Roth IRA. If you are over the age of fifty, you’re allowed to contribute up to $8,000 to each. But what’s the difference between them?

The traditional IRA is funded with pre-tax dollars, meaning that you will pay taxes when you withdraw the funds. The benefit of this is that it lowers your current taxable income which could translate to big tax savings. However, it’s likely that you will be taxed at a higher rate in the future when you withdraw your retirement funds.

On the other hand, the Roth IRA is funded with post-tax dollars. This means you have already paid the taxes on the money you used to fund the account. The benefit is that both you and your employees will be able to withdraw funds tax-free in retirement. These types of retirement accounts can be a huge benefit for your team.

Additional Considerations for IRAs and Roth IRAs

There are restrictions and guidelines that must be followed when using IRAs. The IRS regulates how much can be contributed, when money can be pulled from the accounts, and who can contribute to them.?

For example, one of the rules that govern who is allowed to contribute states that the contributor must be employed or have income. At one time, I employed my children who were paid to do actual jobs within my office. As a result, they were eligible to contribute to a traditional IRA or a Roth IRA.?

Now, there are some rules that apply to one but not the other. So, let’s take a closer look at the rules that apply to deductions and contributions.

If you earn too much money, you won’t receive deductions using a traditional IRA. With the traditional IRA, a married and filing jointly couple receives no deduction in 2024, if they make more than $143,000 according to their modified adjusted gross income (MAGI).?

On the flip side of the coin, if you make too much money ($240K or more, as a married couple filing jointly in 2024), you cannot contribute to a Roth IRA. These are important details to consider when thinking about whether a traditional or ROTH IRA is a good option for you and your team.

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The SIMPLE IRA

According to the IRS, a SIMPLE IRA is defined as a Savings Incentive Match Plan for Employees. If you paid close attention to that sentence, you probably noticed that SIMPLE is an acronym. Essentially, it is a company-sponsored plan in the same way that a 401(k) is. Pretty simple stuff, right? See what I did there?

So, this probably has you scratching your head and asking, “Why don’t I just use my traditional IRA?” Well, think of it this way, in 2024, if you are under the age of 50, the traditional IRA will allow you to contribute a maximum of $7,000 each year. However, the SIMPLE IRA will allow you to contribute a maximum of $16,000 each year. That’s more than double what your traditional allowance is. Here’s the kicker. If you’re over the age of fifty, you can contribute a total of $19,500 per year by taking advantage of the maximum “catch up” allowance.

There are a couple of groups that really benefit from a SIMPLE IRA. Traditionally, if you have just begun to pay yourself and you’re maxing out your Roth but you want to save a little more, the SIMPLE is a great option. Another group is the business owner that has a good talent group but is trying to recruit more talent to their pool. You want to attract prospects to you and your business, and a SIMPLE IRA is an easy way to offer retirement plans to your employees without having to go the 401(k) route.?

401(k) Plans

Speaking of 401(k)s… Most of us have heard of and probably even used a 401(k) account at some point in our lives. But do you really understand what it is? In the most simplistic terms I can think of, a 401(k) is a qualified retirement account that allows you to save and invest money on a tax-deferred basis. The money grows within the account and is taxed when it is withdrawn. However, there are heavy tax penalties for withdrawing funds before you’ve reached retirement age.

There are several main options that you have, as a business owner, for establishing a 401(k). They serve a variety of functions ranging from tax minimization to employee retention. Some of the things you want to look at, regardless of what your goals are for establishing a 401(k), are employee contribution limits, vesting schedules, and the overall cost to you, the business owner.

Let’s begin with the contribution limits. In 2024, your employees will be able to make contributions of up to $23,000 to their 401(k) accounts. Employees who are 50 or older will be able to contribute an additional $7,500, meaning they can contribute a maximum of $30,500 per year.

The total combined contribution (your employee’s contributions along with matching contributions by your company) is limited to the lesser of $69,000 ($76,500 if your age is above 50), or 100% of your team member’s salary.

As for the costs, they can be wide and varied. It really depends on the details of the plan and how you’ve chosen to bundle or unbundle your providers. If you bundle, you’re more likely to save on the costs associated with a 401(k). But what about that vesting schedule?

Vesting Schedules

Vesting is a great way to achieve employee retention. Basically, you decide — within the plan document — when the money that you contribute to the employee’s account becomes theirs. As a business owner, you actually have some choices when it comes to vesting your company’s 401(k) contributions.?

One of the best long-term vesting schedules, in my opinion, is the six-year graded schedule. Basically, each year the employee works for you they earn a higher percentage of the money that you’ve contributed on their behalf. So, if they’ve been at your company for less than a year, they own 0% of your contributions. That number goes up to 20% after their first year, and so on and so forth until they reach the sixth year and own 100% of the contributions.

Another common type of vesting schedule is the three-year cliff. This is similar to the six-year graded schedule insofar as the employee must work for a set number of years before being able to take ownership of your contributions. The difference is that, with the cliff, the employee owns 0% until they have worked for you for three years. At that point, they own 100% of the contributions made by you.

In addition to the ability to set vesting schedules, you could enjoy other benefits and retention tools depending on which type of 401(k) plan you choose for your team.

The Safe Harbor Provision

The safe harbor provision is one of my personal favorites. Basically, the IRS gives you a safe harbor or a free pass from some plan testing that you might otherwise have to do. Meaning, once per year, a third-party administrator examines your plan to see what you’ve contributed — as the business owner — versus what your employees contribute. If it is too great of a difference, you’re subject to penalties.

In order to qualify for the safe harbor, you must contribute to your employee’s account either through a safe harbor match or a safe harbor non-elective contribution. The match means that you must contribute by matching up to 3 percent of salary and 50 percent of contributions above 3 percent, but below 5 percent. If the employee isn’t contributing to their account, then you don’t have to do so.

However, the safe harbor non-elective contribution requires that you contribute at least 3% of your employee’s salary into their account. The business owner contributes whether their employees contribute or not. The non-elective contribution is one that you — the business owner — must make to all of your employees, across the board.

Why Safe Harbor?

As the owner of a small business, the last thing you want to hear is that you’ve been found wanting after being tested and that your contributions to your retirement fund are going to be returned to you. It creates a mess, both for your retirement savings and to your tax minimization plans. So, receiving that pass on annual plan testing from the IRS is a huge benefit.

Now, you need to be aware that there is a maximum income cap on the safe harbor provision. If you make more than $330,000 — as of 2023 — you can only receive the 3-4% match on the first $330,000 you make. So, if you’re a business owner making a million dollars a year, you can only receive the company’s contribution match on the first $330,000.

The Profit-Sharing Provision

Another great feature that you could incorporate into your business’ 401(k) plan is the profit-sharing provision. Essentially, the company contributes to your and your employees’ accounts out of the profits earned. The simplest form of profit-sharing is pro-rata, where everyone gets the same contribution across the board. If you — the owner — receive 2%, so does each of your employees. In most cases, that 2% is based on the individual’s salary.

New comparability profit-sharing is the most common form seen today. You would use the new comparability form to maximize yourself and, maybe, a few key employees. Employees still receive a share of the profits, but it isn’t like the pro-rata plan where everyone receives the same amount. With the new comparability form of profit-sharing, the business owner can take a larger slice of the pie.

A few things need to ring true in order for the new comparability form of profit-sharing to work really well. If you are older than your employees, that helps because the IRS thinks, “Well, she doesn’t have as long to save for retirement as her employees do.” Income disparity is another factor. If you give yourself a $32,000 W-2, it’s going to be much more difficult to give yourself a larger share of the profit-sharing than if you reported a larger income.

The Cash Balance Plan

Cash balance plans are a type of defined benefit plan. It’s similar, in concept, to your grandfather’s pension, where he would draw a monthly check from his pension. A 401(k) carries whatever balance you have contributed and earned. Conversely, the cash balance plan can net you a maximum benefit of $265,000 per year, as of the time of this writing. It is a defined benefit plan, paying a set amount each year upon retirement. Typically, you would use the cash balance plan in conjunction with a 401(k) plan.

How Much Can You Save with a Cash Balance Plan?

In 2023, depending on your individual situation, you can save anywhere from $69,000 to $398,000 annually . The older you are, the closer you will be to the top end of that range. Basically, you combine your 401(k), safe harbor, and profit-sharing options with the cash balance contributions to put back massive retirement savings.

So how do you know if the cash balance plan is right for you? Well, it’s important to realize that the cash balance plan is entirely employer funded. Therefore, your business needs to be profitable and steady. If you’re doing great this year but maybe you were in the red last year, it’s probably not a good plan for you.?

The reason for this is that, in general, the plan must “cover” at least 40% of all owners + employees who have met the eligibility requirements (but no fewer than two if at least two have met the eligibility requirements).

In addition, if the employer maintains a 401(k)/profit-sharing plan alongside the cash balance plan (which is often the case), the employer contributions to both plans are aggregated. In a perfect world, one with a significant age gap between the owner and employees, a total employer contribution is equal to around 9% of their total wages (2% as cash balance and 7% as profit sharing). Now, if you have a very large company, there are ways to avoid including everybody but you still need the budget to do so.

Conclusion

Friends, as you can see, you have several options for retirement plans as a business owner. It could be a good idea to reach out to your trusted team of professionals to investigate what could be your best option for your business. Each option offers unique tax benefits and enables you to put the “golden handcuffs” on your team members.?

This means that you and your employees can enjoy mutual tax and retirement benefits while you enjoy the added bonus of attracting and retaining top talent through an attractive benefits package.