Types of Qualified Retirement Plans Utilized by Startups and Early Stage Companies
Many employers feel it is necessary, as part of a competitive recruitment process, to adopt a tax qualified retirement-savings plan for employees. Here are some forms of tax qualified retirement plans early stage companies often consider:
Standard 401(k) Plans
401(k) plans are funded primarily by pre-tax contributions of employees. These plans allow employees to defer paying taxes on their contributions until they receive the money in retirement. Employers can also match some or all of the employee’s contributions. Typically, for employers to avoid liability for investment losses, the employer selects a broad and prudent slate of investment alternatives and the participants elect how they want to invest their account among those choices. These plans are subject to annual filings with the Department of Labor and non-discrimination testing (meaning that they cannot disproportionately benefit highly compensated employees), so many employers adopt a “safe-harbor” matching contribution design which allows the plan to be exempt from the testing. There are several “safe-harbor” options and a qualified benefits attorney or plan broker can help a company determine which alternative is the best fit for the company. 401(k) plans may also allow participants to withdraw money from their plan account prior to retirement in the form of a loan, or upon a specified financial hardship.
Automatic Enrollment 401(k) Plans
In automatic enrollment 401(k) plans, employees are enrolled automatically and contributions are deducted from their paychecks unless they opt out in writing. Automatic enrollment 401(k) plans can increase plan participation among rank-and-file employees, which allows assets to build more quickly within the plan. Higher trust balances in your plan can translate to lower investment and administration cost.
Savings Incentive Match Plans for Employees of Small Employers (SIMPLE IRA and SIMPLE 401(k))
SIMPLE IRAs and 401(k)s allow employers with no more than 100 employees to sponsor a relatively simple to administer retirement plan (pun intended). SIMPLE IRAs may require that eligible employees were compensated at least $5,000 in their previous two years of employment and also at least $5,000 during their first year of eligibility. A SIMPLE 401(k) may be designed to require one year of service and to be at least age 21 before an employee can participate, but the rules for both forms of SIMPLE can be less stringent if the employer desires. In both plans, participants can receive a fully vested employer matching contribution of up to 3% of the employee’s pay. Employers may reduce that amount if business conditions vary from year to year. A SIMPLE 401(k) may offer plan loans for special circumstances, much like in a standard 401(k), but a SIMPLE IRA does not allow participant loans. SIMPLE plans require few administrative burdens since the bank or financial institution receiving the funds does most of the paperwork. No non-discrimination testing is required and neither are annual Department of Labor filings. The maximum amount of compensation that a participant can defer is slightly less with the SIMPLEs than with a standard 401(k) plan – generally, for 2017 the deferral limit for SIMPLE is $12,500 compared to $18,000 for a standard 401(k) plan (though participants over 50 may contribute additional amounts as “catch-up contributions”).
Payroll Deduction Individual Retirement Accounts (IRA)
An employer can also set up a basic payroll deduction IRA program with a bank or other financial institution, and the employees can choose whether and how much they want deducted from their paychecks and deposited into the IRA (up to that year’s annual limit, which for 2017 is $5,500 (or $6,500 if the employee is over 50). Employees may also have a choice of investments depending on the IRA provider. However, the employer cannot make matching contributions to a payroll deduction IRA like it can with the SIMPLE IRA.
Profit Sharing Plans
Profit sharing plans only allow employer contributions, though a profit sharing feature may be added to a standard 401(k) plan if the employer wishes to share profits with its employees in a tax-deferred manner.
Defined Benefit Plans
A defined benefit plan is designed to provide each participant with a fixed income at retirement and should only be adopted by employers with very predictable profitability and cash flow. These plans are becoming the dinosaurs of benefits because of strict employer funding rules, workforce mobility and administrative cost. If interested in providing a more traditional employer paid pension scheme for philosophical reasons, employers should consult with legal and investment advisors before proceeding and during the plan design process.
Simplified Employee Pension (SEP) Plan
A SEP allows an employer to provide an employer paid retirement program with deductible contributions without getting involved in more complex defined benefit retirement plans. Under this type of retirement plan, an employer makes contributions on behalf of its employees to an individual retirement arrangement called a SEP-IRA. While an employer has an active SEP it cannot maintain any other type of retirement plan, so these are best utilized by small employers who don’t anticipate workforce growth. You can even have a SEP if you are self-employed!
There are a lot of complex choices to make in this space, and we caution clients to understand both what appeals to their employees and what their obligations as an employer will be in connection with these plans before adopting one. If you have any questions about employer sponsored retirement plan selection or adoption, please comment below, email me, or connect with me on LinkedIn or Twitter.
The blog content should not be construed as legal advice.
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