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How To Choose an Investment Vehicle For Your Small Business
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Business New Haven
11/11/2002
By: Karen Singer
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Although more than 40 million Americans work for businesses with fewer than 100 employees, only about eight million are earning pension benefits, according to the U.S. Department of Labor.
Often used by large companies as incentives aimed at attracting and keeping productive workers, retirement plans also can be advantageous to small businesses, not only as a future source of income but also for more immediate tax advantages.
Moreover, recent tax changes have made some options even more appealing for small employers, so those who have a plan should make sure they're up to date on the latest developments, and those without a plan might want to consider implementing one.
The trick is to figure out which type of plan best suits your business, and tailor it to fit your needs.
The first hurdle is to determine your company philosophy regarding such plans, and whether you want to structure yours purely to be an employee benefit or to produce the maximum benefit to the owner at low employee costs.
Factors to consider include number and type of employees as well as how large a benefit you wish to give them. Some plans have age or hour limits that may be important in determining who you want to include.
Pension plans generally are designed to grow tax-free and pay out at retirement, when the money becomes taxable. Withdrawals are subject to current federal income taxes and stipulate penalties for premature withdrawal – usually 10 percent if the participant is under age 59 and one-half.
Most small employer plans are either defined benefit plans or defined contribution plans. A defined benefit plan provides a specified benefit at retirement, such as $150 a month. The amount of the benefit generally is determined by a percentage of pay multiplied by the number of years of employment. Employers must contribute enough to fund the promised benefit.
Retirement benefits are not specified in defined contribution plans, which require employee and/or employer contributions, sometimes at a fixed rate.
Probably the best-known type of defined contribution plan is the 401(k), whose main advantage is to allow employees to contribute more than in other plans.
Available to any business with at least one employee, the plan must be offered to all employees at least 21 years of age who worked at least 1,000 hours in the previous year.
401(k) plans typically are funded by employee salary reduction contributions and/or employer contributions. But they can be structured in many ways so it's best to seek help from a financial institution or employee benefit advisor.
Employee contribution limits to 401(k) plans grew from $10,500 in 2001 to $11,000 in 2002 with $1,000 annual increments until a limit of $15,000 in 2006. Combined employer and employee contributions recently were raised from a maximum of 15 percent of compensation or a maximum of $35,000 in 2001 to a maximum of 25 percent of compensation or a maximum of $40,000 this year.
Another option is the SIMPLE/IRA, a salary reduction plan requiring little paperwork that is available to businesses with 100 or fewer employees without any other retirement plan. The SIMPLE plan can be structured with employee salary reduction contributions, which were raised from $6,000 per year to $7,000 in 2002 and/or employer contributions.
Employees decide how much to contribute, but employers must make matching contributions or contribute two percent of each employee's salary up to a set maximum.
The SEP-IRA requires only employer contributions. Limits were raised in 2002 to as much as 25 percent of compensation or a maximum of $40,000, up from 15 percent of compensation or a maximum of $35,000.
Other types of defined contribution plans include profit-sharing plans and money purchase plans, which until recently allowed employers to boost the amount of contributions allowed through other plans.
Some financial advisers say 2002 tax changes permitting increases in contributions in those other plans – as well as penalties for employers failing to make contributions – have made money purchase plans a less desirable option for small employers these days.
Limits for payroll deduction plans, another relatively easy option, also were raised in 2002, up from $2,000 to $3,000. Employees decide on how much to contribute.
Profit sharing plans, under which employers make contributions, also were affected by tax changes in 2002. Contributions grew from up to a maximum of 15 percent of salary or a maximum of $35,000 in 2001 to a maximum of 25 percent of salary or a maximum of $40,000 this year. These plans must be offered to all employees 21 years or older who worked at least 1,000 hours in previous year.
Once money is put into a retirement plan, it has to be invested, which is done either by business owners or outside administrators. With an unpredictable financial market these days, employers understandably are concerned about their fiduciary responsibility and are turning more to outside help. Such advisors are advocating employers offer a broad range – at least three or more types – of investment vehicles, and that investment decisions are made by employees.
Before choosing a pension plan, however, it's best to examine all the options in detail, particularly in terms of qualifications and employee costs.
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