If you are running a company, sooner or later you will need a retirement plan in order to compete for workers. For a small company, the top three options to look at are: SEP-IRAs, SIMPLE-IRAs and 401Ks. Each has their own unique sets of rules and may be the right choice for you.
SEP-IRA
Typically, SEP-IRAs are recommended for self-employed situations. It is an easy plan to implement with high contribution limits and little administration overhead. If your business is incorporated, you can contribute 25% of wages to a retirement plan. If not incorporated, you can contribute 20% of net profit. In addition, you can sign your company up directly with Vanguard at no additional costs over an individual IRA account. Sounds good, right? There is one slight complication -- the contributions are made in addition to salary by the employer only and must be applied at the same rate to all employees. This makes individual choice very limiting for both company owners and employees. Owners typically will want to shelter as much income as possible but if they put the maximum 25% of their salary away into tax-deferred space, every employee would receive a similar contribution. Likewise, any employee wanting to accelerate their retirement savings would not have the option to do so.
(A Keogh plan looks very similar to a SEP-IRA except for pre-declared contribution percentages and more paperwork since it is a pension plan. With the advent of the SEP-IRA, there should be no reason for a small company to choose a Keogh.)
SIMPLE-IRA
SIMPLE-IRAs are available for companies with 100 employees or less and operate like 401Ks. Employees decide how much of their salary they want to defer and the employer makes matching contributions. Employees must make either 2% matching to all employees whether they participate or not -- or up to 3% elective 3 out of 5 years. Both matching schedules require immediate vesting.
Reasons for choosing this plan -- one page annual filing, low cost of administration. Like with a SEP-IRA, you can open up an account directly with Vanguard at the cost of an annual $25 per fund used per employee. (The fee is paid by the employee until they accumulate $100K in total assets at Vanguard.) As the I in IRA stands for individual, employees have the right to withdraw or rollover any contributions after a 2 year waiting period.
Now for the bad:
401K
If you are a hermit who just left your cave, read up about 401K plans at Investopedia. Otherwise, there's no point in going over basics you should know already or can read about on anywhere else. Instead, I'll jump right to employer issues.
Cost -- You will not be able to setup and make the annual ERISA filings yourself. You will have to hire a third party administrator to manage the plan for you. The big boys (Vanguard, Fidelity, T.Rowe Price, etc.) only will deal with you directly if you have enough plan assets or are willing to pay a nice annual fee. This means you must be diligent investigating the fee schedules. Here is a Boggleheads post I wrote a few months back listing about a dozen low-cost 401k options.
Plan Testing -- The IRS frowns on deferring too money for owners and highly paid employees (97K+ for 2007, 102K+ for 2008). Hence, annual contributions must be tested against formulas. If a plan is deemed top heavy, contributions must either be returned (don't file those individual tax returns early) or additional matching must be made on behalf of non-highly paid employees. In a small company where a large percentage of employees could be highly paid, this ends up being a crippling limitation. Luckily, there is a solution called the Safe Harbor 401k. It simply is a regular 401k except with mandatory 100% matching up to the first 3% of salary and another 50% for the next 2% with immediate vesting. Additional matching is possible but where discretionary (ie, depends on profits), it is capped to 4% total on 6% of salary.
The plan my company switched to was a Safe Harbor 401k administered by Employee Fiduciary. My next posts will talk about the plan EF offers and the funds we picked.
SEP-IRA
Typically, SEP-IRAs are recommended for self-employed situations. It is an easy plan to implement with high contribution limits and little administration overhead. If your business is incorporated, you can contribute 25% of wages to a retirement plan. If not incorporated, you can contribute 20% of net profit. In addition, you can sign your company up directly with Vanguard at no additional costs over an individual IRA account. Sounds good, right? There is one slight complication -- the contributions are made in addition to salary by the employer only and must be applied at the same rate to all employees. This makes individual choice very limiting for both company owners and employees. Owners typically will want to shelter as much income as possible but if they put the maximum 25% of their salary away into tax-deferred space, every employee would receive a similar contribution. Likewise, any employee wanting to accelerate their retirement savings would not have the option to do so.
(A Keogh plan looks very similar to a SEP-IRA except for pre-declared contribution percentages and more paperwork since it is a pension plan. With the advent of the SEP-IRA, there should be no reason for a small company to choose a Keogh.)
SIMPLE-IRA
SIMPLE-IRAs are available for companies with 100 employees or less and operate like 401Ks. Employees decide how much of their salary they want to defer and the employer makes matching contributions. Employees must make either 2% matching to all employees whether they participate or not -- or up to 3% elective 3 out of 5 years. Both matching schedules require immediate vesting.
Reasons for choosing this plan -- one page annual filing, low cost of administration. Like with a SEP-IRA, you can open up an account directly with Vanguard at the cost of an annual $25 per fund used per employee. (The fee is paid by the employee until they accumulate $100K in total assets at Vanguard.) As the I in IRA stands for individual, employees have the right to withdraw or rollover any contributions after a 2 year waiting period.
Now for the bad:
- Lower contribution limits compared to SEP-IRAs and 401Ks. For 2007, employee contributions are limited to 10.5K versus a 401K's 15.5K. Catchup contributions for employees over 50 are 2.5K versus a 401K's 5K.
- An employer may not match more than 3%. My guess this is to avoid self-employed from contributing 10.5K + 328% matching to reach the 45K maximum qualified plan limit on ~50K of income.
- $25 per fund charge at Vanguard means employees must pick a single target retirement fund to avoid extra fees until they build up a significant amount of money.
401K
If you are a hermit who just left your cave, read up about 401K plans at Investopedia. Otherwise, there's no point in going over basics you should know already or can read about on anywhere else. Instead, I'll jump right to employer issues.
Cost -- You will not be able to setup and make the annual ERISA filings yourself. You will have to hire a third party administrator to manage the plan for you. The big boys (Vanguard, Fidelity, T.Rowe Price, etc.) only will deal with you directly if you have enough plan assets or are willing to pay a nice annual fee. This means you must be diligent investigating the fee schedules. Here is a Boggleheads post I wrote a few months back listing about a dozen low-cost 401k options.
Plan Testing -- The IRS frowns on deferring too money for owners and highly paid employees (97K+ for 2007, 102K+ for 2008). Hence, annual contributions must be tested against formulas. If a plan is deemed top heavy, contributions must either be returned (don't file those individual tax returns early) or additional matching must be made on behalf of non-highly paid employees. In a small company where a large percentage of employees could be highly paid, this ends up being a crippling limitation. Luckily, there is a solution called the Safe Harbor 401k. It simply is a regular 401k except with mandatory 100% matching up to the first 3% of salary and another 50% for the next 2% with immediate vesting. Additional matching is possible but where discretionary (ie, depends on profits), it is capped to 4% total on 6% of salary.
The plan my company switched to was a Safe Harbor 401k administered by Employee Fiduciary. My next posts will talk about the plan EF offers and the funds we picked.
Subscribe
Leave a comment