Business Retirement Plans give owners of businesses with and without employees a powerful savings tool and valuable tax deductions.
A Profit Sharing 401(k) plan allows contributions through three different methods: employer profit sharing, matching and employee 401(k) salary deferrals.
- Contributions can be allocated based on the amount of each participant’s compensation, job class, and/or age. The employer may vary the contributions year to year, ranging from 0 to 25% of eligible compensation, considering no more than $270,000 (2017 index) individually as compensation.
- The deadline for company contributions is the company’s year-end tax return deadline including extensions. For eligibility, the employer may be more lenient, but not stricter than excluding any employee: under age 21, less than 1 year of service (may be 2 years if 100% vested), under 1,000 hours per year and union employees.
- Employer contributions may come under a vesting schedule. Vesting is the employees’ right to the employers’ contribution. The most common schedule is 20% per year up to six years and goes 0-20-40-60-80-100%. Vesting may start at date of hire or for new plans, everyone may start at 0% vesting.
- The forfeitures under vesting may be reallocated to the remaining employees as a percent of compensation or used to reduce employer contributions. 401(k) / ADP Test Employees may contribute 100% of compensation up to $18,000 (2017 index). All employee contributions will be 100% vested. There are no Federal or State income taxes (for most states) on 401(k) contributions.
- The Actual Deferral Percentage (ADP) test must be passed where the average of the non-highly compensated employees is calculated and the highly compensated employees may contribute a slightly higher average.
- Individuals age 50 or older may contribute an additional catch-up contribution of $6,000 in 2017. This will not be subject to any tests (ADP) or limits. Employers may also allow for Roth 401(k) contributions. These contributions are after-tax and therefore not taxed at retirement.
- Employers may require an Automatic Enrollment provision with a 30 day employee notice. This usually deducts about 3-10% of compensation unless employees opt out within 90 days after the first salary deferral.
- The employer may offer a match, to increase participation, which can come under a vesting schedule. For example, 25¢ on the $1 up to 4% of pay. The match may be discretionary, as long as the employer allows the employees to change their 401(k) election if the match is changed.
- Top-Heavy Test If your plan is top-heavy (the total of the accounts of all key employees exceeds 60% of the total of the accounts of all employees) you are required to make a minimum contribution to non-key employees equal to the lesser of 3% of compensation or the highest contribution percentage rate for a key employee
Safe Harbor Options
- An employer may choose to make a 100% vested contribution (except auto enroll) to the employees to pass the ADP and top-heavy tests.
Profit-Sharing Plan accepts discretionary employer contributions. There is no set amount that the law requires you to contribute. If you can afford to make some amount of contributions to the plan for a particular year, you can do so. Other years, you do not need to make contributions. Also, your business does not need profits to make contributions to a profit-sharing plan.
If you do make contributions, you will need to have a set formula for determining how the contributions are divided. This money goes into a separate account for each employee.
One common method for determining each participant’s allocation in a profit-sharing plan is the “comp-to-comp” method. Under this method, the employer calculates the sum of all of its employees’ compensation (the total “comp”). To determine each employee’s allocation of the employer’s contribution, you divide the employee’s compensation (employee “comp”) by the total comp. You then multiply each employee’s fraction by the amount of the employer contribution. Using this method will get you each employee’s share of the employer contribution.
If you establish a profit-sharing plan, you:
- Can have other retirement plans
- Can be a business of any size
- Need to annually file a Form 5500
As with 401(k) plans, you can make a profit-sharing plan as simple or as complex as you want. You may purchase a pre-approved profit-sharing plan document from a benefits professional or financial institution to cut down on administrative headaches.
Pros and Cons
- Flexible contributions – contributions are strictly discretionary
- Good plan if cash flow is an issue
- Administrative costs may be higher than under more basic arrangements (SEP or SIMPLE IRA plans)
- Need to test that benefits do not discriminate in favor of the highly compensated employees.
Who contributes? Employer contributions only. If a salary deferral feature is added to a profit-sharing plan, it is a “401(k) plan.”
Contribution limits- The lesser of 25% of compensation or $55,000 (for 2018; $54,000 for 2017, subject to cost-of-living adjustments for later years).
Filing requirements– Annual filing of a Form 5500-series return/report is required. Participant disclosures are also required.
Participant loans– Permitted.
In-service withdrawals? Yes, but subject to possible 10% additional tax if under age 59-1/2 and no other exception applies. A Profit Sharing 401(k) plan allows contributions through three different methods: employer profit sharing, matching and employee 401(k) salary deferrals.
A Solo Defined Benefit Plan helps self-employed and small business owners save aggressively for retirement by allowing you to make very high contributions. Just target a desired level of retirement income, and contribution amounts are adjusted each year to help you reach your goal. A Solo Defined Benefit Plan may be best for professionals age 50 or over who can make annual contributions of $80,000 or more for at least five years and who have few, if any, employees. It’s for people who are looking for a quick way to increase their retirement assets, most likely highly compensated professionals, consultants, business owners, partners, and key employees who are in their peak earning years.
Contributions are generally 100% tax-deductible, within IRS limits. Earnings grow tax-deferred and are taxable when withdrawn.
A Solo Defined Benefit Plan is funded with employer contributions and funded annually. Annual contribution levels are calculated based on several factors, including age, compensation, and retirement age. If you have employees, you must contribute for all eligible employees. Plan contributions are adjusted each year and may be amended if the desired contribution level needs to be revised.
This plan is for the business owner with no employees. The business owner wears two hats in a 401(k) plan: employee and employer. Contributions can be made to the plan in both capacities. The owner can contribute both:
- Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
- $18,500 in 2018, or $24,500 in 2018 if age 50 or over; plus
- Employer non-elective contributions up to:
- 25% of compensation as defined by the plan, or
- for self-employed individuals, see discussion below
Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.
- Available to any size business
- Easily established by adopting Form 5305-SEP, a SEP prototype or an individually designed plan document
- No filing requirement for the employer
- Only the employer contributes
- SEP-IRAs set up for each eligible employee
- Employee is always 100% vested in (or, has ownership of) all SEP-IRA money
Employee Stock Ownership Plan (ESOP) is an IRC section 401(a) qualified defined contribution plan that is a stock bonus plan or a stock bonus/ money purchase plan. An ESOP must be designed to invest primarily in qualifying employer securities as defined by IRC section 4975(e)(8) and meet certain requirements of the Code and regulations. The IRS and Department of Labor share jurisdiction over some ESOP features.
Simple IRA plan (Savings Incentive Match PLan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.
Simple IRA plans can provide a significant source of income at retirement by allowing employers and employees to set aside money in retirement accounts. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan.
- Available to any small business – generally with 100 or fewer employees
- Easily established by adopting Form 5304-SIMPLE, 5305-SIMPLE, a SIMPLE IRA prototype or an individually designed plan document
- Employer cannot have any other retirement plan
- No filing requirement for the employer
- Contributions: Employer is required to contribute each year either a:
- Matching contribution up to 3% of compensation (not limited by the annual compensation limit), or
- 2% non-elective contribution for each eligible employee. Under the “non-elective” contribution formula, even if an eligible employee doesn’t contribute to his or her SIMPLE IRA, that employee must still receive an employer contribution to his or her SIMPLE IRA equal to 2% of his or her compensation up to the annual limit of $275,000 for 2018 (subject to cost-of-living adjustments in later years)
- Employees may elect to contribute
- Employee is always 100% vested in (or, has ownership of) all SIMPLE IRA money
At Marin Wealth Advisors, we are Registered Investment Advisors who can help you determine the business retirement plan that best meets your needs. We educate you about the different types of business retirement plans, including their advantages and disadvantages. You might prefer any of these options, depending on your financial situation and retirement goals:
- Individual 401(k) Plan
- Simplified Employee Pension Plan Individual Retirement Account (SEP-IRA)
- Simple IRA
- Profit Sharing Plan
- Combined 401(k) and Profit Sharing Plan
- Employee Stock Ownership Plan (ESOP)
- Solo Defined Benefit Plan
Once we help you make your selection, we work with you to manage your retirement assets in the most cost-effective and productive way. Whichever plan you choose, we help you optimize your retirement contributions and access the benefits the particular account offers you.