401(k) Guide for Small Businesses: Which Type of Retirement Plan is Right for You?

OWith more than a dozen states requiring small businesses to offer a retirement program to their employers, and other states debating similar legislation, the incentive for your small business to offer a retirement program has never been greater. However, it can lead to the question, “What kind of program is right for my business?”

In this article, we’ll review the different types of employer-sponsored retirement programs and explain their merits so you can make the choice that’s best for your business and your employees.

Plan Type #1: 401(k) Plans

With over 100 million retirement plan participants, the 401(k) is by far the most popular type of employer-sponsored retirement program. A 401(k) is a type of defined contribution plan, which means that employees decide how much to contribute to their account, up to the maximum amount of $20,500 in 2022. This type of plan is flexible, allowing employers to offer either a traditional plan or a Roth plan.

In a traditional 401(k), contributions are deducted from an employee’s paycheck before income tax is calculated, giving them immediate tax savings. In a Roth 401(k), contributions are made in after-tax dollars, so even though employees contribute less on average, they won’t have to pay taxes on their contributions after age 59 and half. Contributions are invested in mutual funds and other investment vehicles, which tend to increase in value over time and can provide a comfortable retirement.

Plan Type #2: SINGLE IRA

A SIMPLE IRA plan, as the name suggests, offers small businesses a simplified way to contribute to the retirement savings of their employees and the business owner. SIMPLE IRA plans are limited to businesses with less than 100 employees, so this is a really small, employer-focused plan. In addition, like a 401(k) plan, employees can choose to contribute to the plan on a pre-tax basis, which gives them immediate tax benefits.

The biggest difference between a 401(k) and a SIMPLE IRA is that employees can contribute up to $20,500 into a 401(k) versus only $14,000 into a SIMPLE IRA. Second, SIMPLE IRA plans lack the flexibility that is built into a 401(k) plan. Employers must contribute 2-3% of an employee’s salary with very little flexibility as to who is eligible. This applies even if the employee does not contribute himself.

With the falling costs of setting up a 401(k) plan, many business owners are opting for a 401(k) over a SINGLE IRA because the cost of 401(k) plans has come down these last years.

Plan Type #3: SEP (Simplified Employee Retirement) Plans

SEP plans are most often offered by sole proprietors or other self-employed people. In summary, these plans are similar to SIMPLE IRA plans with one key difference: employees cannot add optional contributions to an SEP plan; only employers can contribute. To that end, SEP plans also give employers much more flexibility in when they contribute and how much each contributes.

Plan Type #4: Profit Sharing Plans

A profit sharing plan is a defined contribution plan that allows employers to make a contribution as a percentage of plan compensation or a fixed dollar amount, depending on the terms of the plan document. Employers can decide the amount of contributions based on company profits or other cash flows after the end of the plan year. These plans offer employers flexibility in plan design, including fixed or discretionary contribution formulas.

Learn more about incentive plans here>>

Plan Type #5: Employee Stock Ownership Plans (ESOPs)

Employee stock plans allow companies to provide stock to their employees, usually by holding the provided stock in a trust for security and growth until the employee retires or resigns. After this exit event, the company buys back the acquired shares from the employee, with the money flowing back to them in a lump sum or in periodic installments, depending on the plan.

A key advantage that ESOPs offer over other forms of retirement programs is that they make employees care about the overall performance of the business, as employees seek to increase the value of their own shares.

Plan type #6: Plans with cash balance

Do you mainly work with older employees? In this case, a cash flow plan may be the solution for you. Cash balance plans give employees an account similar to a 401(k), but with two key differences:

  • Earnings do not accrue based on investment performance. Instead, they increase by a fixed percentage each year, generally in line with the yield on 30-year Treasury bills.
  • Cash contributions depend on age. The older the participant, the higher the amount because they have fewer years to save before their eventual retirement.

If your small business is in an industry that has older employees on average, offering a cash balance plan could go a long way in attracting and retaining top talent.

Interested in starting a new plan? Take the first step here.

Running a small business is hard, but running your 401(k) shouldn’t be. Fortunately, Vestwell can help. Vestwell is a digital retirement plan platform that makes it easier for you to offer and administer a company-sponsored 401(k) or 403(b). By combining technology with best-in-class retirement plans and user-focused design, Vestwell offers a wide range of services to small businesses everywhere.

If you are an employer interested in setting up a 401(k) account for your business, you can contact Vestwell to determine if you are eligible to receive up to $16,500 in tax credits over three years, which can help offset administration costs. Interested? Learn more here.

Originally posted on Vestwell.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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