When it comes to designing a retirement plan, it’s essential to explore all options to find out what is best for you and your small business. Retirement planning as a tax-savings tool is often underutilized by small business owners. Let’s take a look at three types of retirement plans that are great for small businesses.
Cash Balance Plans
The first type of plan that businesses should consider is a cash balance plan. These plans are especially beneficial for employers who wish to fund contributions that are much higher than those allowed under a 401(k) or profit-sharing plan.
These are a type of defined benefit plan. A defined benefit plan, also known as a pension plan or qualified benefit plan, is a program that pays benefits based on factors such as length of employment and salary history. The employer, not the employee, is responsible for all of the planning and investment risk of a defined benefit plan. Benefits can be distributed as fixed monthly payments like an annuity or in one lump-sum payment.
Employer contributions are required in this type of plan. It should be noted that a cash balance plan can be paired with a 401(k) plan, which ultimately allows for higher savings.
For a business owner who is not sure if a cash balance plan is the right choice, think about these questions.
- Are you looking for a plan that allows for large contributions? A cash balance plan is for those who are looking to maximize contributions.
- Are you prepared to contribute at least 7.5% of employees’ salaries each year?
- Is your business profitable and maintaining a consistent cash flow that can be relied upon?
These are just some of the questions that need examination to determine if a cash balance plan is the best choice.
New Comparability Plans
The next type of plan business owners might want to consider is new comparability plans. Like a cash balance plan, a new comparability plan allows for larger contributions. This type of plan is great for employers who need tax deductions and want to maximize contributions for highly compensated employees (HCE) and owners. This plan can also be paired with a traditional or Safe Harbor 401(k) plan.
With new comparability plans, employers have the ability to make a separate contribution for different groups of employees. For example, you can create a group for owners and for highly and non-highly compensated employees. Employees can also be grouped based on other reasons, such as business goals.
Under the Internal Revenue Code, new comparability plans must pass a yearly discrimination test, so this type of plan may not be for every business. They are best suited for businesses where the owners and highly compensated employees are older than other employees. For those that utilize a comparability plan, contributions are not required, and employees are permitted to make contributions.
Safe Harbor 401(k) Plan
The last plan that businesses may consider is called a Safe Harbor 401(k) plan. This plan is the same as a traditional 401(k) plan, but is designed to let business owners and highly compensated employees contribute larger amounts than what may be possible under a traditional 401(k) plan.
The biggest benefit of a Safe Harbor plan is that a business can provide its employees with the same tax benefits as a regular 401(k) plan, but skip the annual testing requirements, which are time-consuming and expensive.
With a Safe Harbor plan, everyone can contribute up to the annual maximum amount, and those age 50 and older can make additional catch-up contributions. Discretionary contributions are permitted as well.
In a Safe Harbor plan, employee contributions are not required, so this type of plan is good for companies where participation is low. However, there are a number of requirements for a Safe Harbor plan.
- Employers have to fund a matching contribution of at least 100% on the first 3% of salary
- Employers also need to fund a 50% match from 3% to 5% of salary
- There are also requirements related to notice and vesting
Retirement Plans help Retain and Reward Employees
Overall, retirement plans have a significant impact on business owners and employees alike—and great plans are a tool to help retain and reward members of an organization. That is why it is so critical to choose the right plan that best fits your needs. To find out more about these plans and what they can do for you and your business, contact your Landmark advisor today.