Should Your Small Business Offer a Retirement Plan?
As a small business owner, it can be hard to know whether you should offer a retirement plan. If you don’t offer one, you aren’t alone. It’s estimated that 74% of small businesses don’t offer a retirement plan to their employees. But even though employers see retirement plans as optional, workers probably don’t. After all, employees will need anywhere from 70% to 90% of their pre-retirement income to maintain their standard of living once they retire.
So, what about your small business? Should you offer a retirement plan or not? Do your employees need one? Before we get to the answers, let’s have a quick overview of retirement plans to make sure we’re all on the same page.
What Is a Retirement Plan?
According to the Department of Labor, a retirement plan is “an employee benefit plan established or maintained by an employer [...] that provides retirement income or defers income until termination of covered employment or beyond.”
Retirement plans allow employees to plan for a future without work. After decades of hard work, a future without work sounds pretty good, right? It does if you’ve planned accordingly.
There are several retirement plans out there you can offer employees. And depending on your state, you may have state-mandated laws requiring that you provide employee retirement plans.
If you’re not in a state that requires a retirement plan, should you offer one or not? To help answer the question, let’s look at some examples of retirement plans.
Examples of Retirement Plans
Navigating the world of retirement planning can be overwhelming, especially if you’re new to the world of retirement. If your head is already spinning (or is about to!), here’s an overview of retirement plans.
Retirement plans fall into three categories:
- IRA-based plans
- Defined contribution plans
- Defined benefit plans
Let’s take a closer look at these plans and what they mean for small business owners and their employees.
IRA-Based Plans
An IRA is an individual retirement account that is easy to start and maintain. Employees can set up an IRA as part of their private plan, but businesses can also offer certain types to employees. IRAs allow employees to choose their contributions and when to withdraw funds. The cherry on top? Contributions are immediately 100% vested, and employees can access their funds from day one.
IRA-based plans include payroll deduction, simplified employee pension (SEP), and savings incentive match plan for employees (SIMPLE). These plans have their differences, including employer eligibility, who contributes, minimum employee requirements, steps to set up the plan, and more. With so many choices, finding an IRA that works for you and your employees should be easy.
Defined Contribution Plans
Unlike IRA accounts, only employers can create defined contribution plans. Defined contribution plans allow employers, employees, or both to contribute a set percentage of an employee’s annual wages. That money is then invested (e.g., stocks, mutual funds, etc.). When the employee retires, they’ll receive distributions.
Defined contribution plans can include:
- Profit sharing
- 401(k) plans (e.g., safe harbor, automatic enrollment, or traditional)
- Multiple Employer Plan (MEP)*
When considering a defined contribution plan, research the retirement plan company you’re working with. Make sure you know what you’re getting into.
*A Multiple Employer Plan lets related small businesses band together to share some of the cost and administration of a retirement plan. If the costs of retirement plans seem too high for your business, an MEP may be the perfect solution. But, MEPs aren’t for everyone. Right now, they are only available for members of trade associations (e.g., retail and service, mining, trucking, and other industries).
Defined Benefit Plans
Defined benefit plans were all the rage until the 1980s. In their hay day, defined benefit pensions accounted for 60% of private sector workers’ pension plans. Now, the number is drastically lower at 4%. Why the shift? To put it simply, it was expensive for businesses to maintain the plans, and difficult to estimate how much money was needed for an employee’s retirement.
Here’s how defined benefit plans work: Businesses fund the plans directly from company profits, and when employees retire, they reap the benefits. But, if business growth slows and profits decline, employees will still need to retire regardless of how the business is doing. And that’s the trouble with defined benefit plans. Declining profits and a generation of employees retiring simultaneously could spell disaster.
Many employers switched to defined contribution plans to save money, as they’re often funded solely by employee contributions.
Pros And Cons Of Retirement Plans
Before deciding whether to provide a retirement plan for your small business, check out the pros and cons first.
Benefits Of Retirement Plans
Retirement plans can be tricky. But the right plan can give you an edge in hiring and keeping top talent. Remember, your employees will retire at some point. And when they do, they’ll need a good bit of money to make ends meet—up to 90% of their pre-retirement income. That’s a lot of money when someone isn’t working anymore. Generally, the benefits for employees are obvious. But what about the benefits for small business owners?
Here are some of the employer benefits to offering retirement plans:
- Employer contributions (if you choose to make them) are deductible from your business income, lowering your annual tax liability
- Employers setting up a 401(k) for the first time may be eligible for business tax credits through the SECURE Act (Setting Every Community Up From Retirement Enhancement) and SECURE Act 2.0
- Employee morale, retention, and work ethic can improve when employees feel that their future is secure
Drawbacks Of Retirement Plans
Believe it or not, there are some negatives when offering retirement plans to your employees. Negatives may include:
- Some defined benefit plans can’t guarantee benefits to employees when they retire
- New employees may have to wait before they begin contributing to their plans
- Withholding employee contributions can be tricky without the right payroll software to help out
Make a workplace retirement plan work for your business and employees. Choose a secure and reliable retirement plan, decide if you want to use a waiting period, and use payroll software with free 401(k) integration to streamline the process.
Final Thoughts
Whatever you decide on, make sure you do your research. Employee retirement plans aren’t one size fits all. Luckily, there are so many options out there that you’ll be able to find the plan that fits your employees’ needs.
A retirement plan can let employees know that their future is safe so they can focus on the here and now and the work in front of them.
This article was written by Mike Kappel from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.
