Low-Cost Retirement Plan Options
Small businesses need to offer a retirement savings plan for employees in order to stay competitive in today’s tight labor market. The federal government estimates that only a little more than half (53%) of businesses with less than 100 employees have a retirement plan for their workers. Yet finding a plan that won’t bust your budget is very doable. Here are some ways to make having a retirement plan affordable for you and beneficial to your staff.
Small businesses with 100 or fewer employees who received at least $5,000 in compensation last year set up a SIMPLE IRA plan. This is done easily by signing an IRS form:
Form 5304-SIMPLE, which allows participants to select their own financial institutions to receive their contributions, or
Form 5305-SIMPLE, which requires participants’ contributions initially to be deposited in the financial institution chosen by the employer.
Under a SIMPLE IRA, employees can choose to make salary reduction contributions up to limits fixed annually rather than receiving these amounts as part of their regular pay. For 2022, the salary reduction contribution limit is $14,000, plus another $3,000 for an employee aged 50 or older by the end of the year.
In addition, the employer contributes matching or nonelective contributions:
Matching contribution. This is a required match of each employee’s salary reduction contribution(s) on a dollar-for-dollar basis up to 3% of the employee’s compensation. (Only compensation up to a set limit–$305,000 in 2022—is taken into account.) This contribution options requires an employer contribution only where employees have elected to make contributions.
Nonelective contribution. If you don’t make a matching contribution, you must make a nonelective contribution, which is 2% of compensation on behalf of each eligible employee who has at least $5,000 (or some lower amount the employer selects) of compensation from the company for the year. Nonelective contributions must be made in the absence of matching contributions whether or not the employee chooses to make any salary reduction contribution.
There is a 60-day notice period—no later than November 2 for a plan run on a calendar year—in which an employer informs employees of their eligibility to participate, the annual employee contribution limit, and the employer’s chosen contribution formula; employees then have until the start of the year to make their decision about their contributions. The notice to employees should also provide a summary description of the financial institution if the employer choses it as well as the fact that the employee can transfer his or her balance without cost or penalty to their own financial institution.
State-mandated retirement plans
If you don’t have a qualified retirement plan, you may be subject to a mandate in your state. This means you must withhold employees’ contributions from their paychecks and then deposit them into a state-run plan. There are no employer contributions. The cost to the employer is the administrative burden of withholding and depositing the employees’ contributions. No employer contributions are permitted. Find details about which states have or are considering such mandated plans from ADP. Links to the state plans, with details about withholding, are provided by ADP.
Payroll Deduction IRA
With this option, an employer doesn’t have a formal retirement plan. The employer merely arranges for all employees to make their own contributions to IRAs. The maximum they can contribute is the usual annual IRA limit (e.g., $6,000 in 2022, plus another $1,000 if age 50 or older by the end of the year). Again, the cost to an employer is the administrative cost for withholding the contributions and transferring them to employees’ accounts.
Pooled employer plans
Employer groups and associations can set up 401(k) pooled employer plans (PEPs) in which individual companies can opt to participate. This type of arrangement allows for larger employee salary reduction contributions than permitted to SIMPLE IRAs, while reducing the administrative costs for employers as well as shifting much of the fiduciary burden (and risk) to a professional administrator, called a Pooled Plan Provider. Any two or more businesses can come together to form a PEP, but it’s primarily designed for trade associations and other companies to create one. For example, Paychex has a PEP option.
If you’re setting up a retirement plan, you may be eligible for one or two federal income tax credits for your efforts. This obviously reduces the cost of having a plan.
If you want to invest more in employees’ retirement savings by setting up your own plan, there are many options, including 401(k) plans, SEPs, and defined benefit (pension) plans. Learn more about these options from an IRS chart for this purpose as well as from the Department of Labor.