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Many businesses do not offer their employees retirement plans. The U.S. General Accounting Office's October 2009 report states that only 29% of businesses with fewer than 25 workers offered retirement plans; such businesses offer fewer benefits generally, and retirement plans are often thought to be expensive and complex. However, many owners of successful long-term businesses do indeed offer a retirement plan, or would like to do so. Not only can the owner participate, but having a good plan makes it easier to draw top employees, especially given continuing doubts about Social Security's long-term viability. Additionally, many successful business owners simply feel that offering a favorable retirement plan is the right thing to do.

If you as a successful business owner already have a retirement plan or intend to implement one, it's critical to undertake two different but related inquiries, as illustrated below. The first inquiry—“What's the right retirement plan for my business?”—begins with looking at the general legal and fiduciary requirements that apply to all retirement plans, and then asking questions about what you want to achieve for yourself and your employees and how you can do that most cost effectively. The second inquiry—“How can I best utilize our retirement plan?”—aims at optimizing existing plans in a number of ways, including benchmarking them against other plans, monitoring and updating them, and making sure that employees are well educated as to their choices under the plan.

This is the first in a series of two articles that will examine these two inquiries in some depth. Importantly, while you can undertake these inquiries on your own, most business owners will make better choices if they receive informed guidance from an experienced financial professional. The next article therefore concludes with a discussion of how to identify and work with the right financial professional.

Legal and Fiduciary Requirements

Business owners are not required to offer a retirement plan. But if you do decide to offer one, then you should make sure you're aware of and in compliance with all applicable state and federal requirements. On the Federal level, the U.S. Dept. of Labor as well as the Employee Retirement Income Security Act (ERISA) must be contended with, and on the state level, in Oregon for example, the State Department of Labor has its own regulations. The ERISA Form 5500 is generally thought to be the most burdensome filing, but as described below, it's not required for certain basic plans.

In addition to protecting against outright malfeasance, the various federal and state regulations and reporting requirements ensure that business owners do not take unfair advantage of retirement plans by offering themselves better terms than their employees. Being in full compliance is important not just to avoid vigilant federal and state regulators (and the civil or criminal penalties they can bestow), but because you don't want an unhappy employee or especially ex-employee to have grounds to sue you. A good way to avoid legal troubles is to create an Investment Policy Statement or “IPS” that describes your retirement plan's goals, policies, procedures, and investment philosophy. An experienced financial professional will be well aware of the various legal and fiduciary requirements and how to put together a strong IPS.

Many Choices

Choosing the right plan involves three steps:

• First, as the business owner you have to decide what type and how complex of a plan to offer in general.
• Second, you have to determine how generous you want to be with respect to offering matching contributions.
• Third, you owe it to yourself and your employees to benchmark the plan you are most likely to go with against similar plans offered by other providers to ensure that the expenses and fees are in line with what is being offered. (Such benchmarking will be discussed in more detail in the next article.)

Through all three of these steps, remember that you, as the owner, are also quite likely to participate in the retirement plan. You'll therefore want to keep your eye on ways to maximize contributions to your own retirement fund, which often necessitates treating your employees more generously as well.

The SEP IRA, or Simplified Employee Pension Plan Individual Retirement Account, is probably the easiest and least expensive plan to implement and maintain (no filings are required). Funded by tax-deductible employer contributions, a SEP IRA must cover all qualifying employees—including the owner as an employee of the business—at the same contribution percentage, up to a maximum of 25% of each employees pay, and allows the owner to personally put away a maximum of $49,000 yearly. Employers can vary the amount they contribute from year to year (down to zero in a given year), and no additional employee contributions can be made. Importantly, while the SEP IRA is indeed easy and inexpensive to implement, it can end up being very costly to fund for the owner who wants to make substantial contributions to his or her own retirement savings and offers far less flexibility than a 401(k) typically offers.

Another relatively easy to set up and maintain plan—again, no major filings are required—is the Savings Incentive Match Plan for Employees or SIMPLE IRA, available to employers with fewer than 100 employees. A SIMPLE IRA enables employees to contribute up to $11,500 yearly (or up to $14,000 for employees over 50), plus a mandatory employer match of up to 3% of the employee's salary, or a mandatory contribution of 2% of each employee's salary up to $4,900. Employees with lower salaries can make larger contributions than under a SEP IRA, but owners (as employee participants) typically cannot contribute as much as they can with a SEP IRA.

Going beyond these IRAs, both in terms of complexity and desirability (in the eyes of existing and potential employees), is a 401(k) retirement plan. Often offered by businesses with more than 25 employees (but perfectly feasible for much smaller businesses), and typically administered by an outside financial institution, a 401(k) requires both Form 5500 filings and IRS filings. A 401(k) is a particularly powerful and versatile type of retirement plan because it can be configured in a variety of different ways with a variety of different features.

For example, a traditional 401(k) does not require an employer match, but most employers do elect to either contribute a percentage of each employee's compensation (a “non-elective contribution”) or match the amount the employee decides to contribute up to specified limits, with the employer's match typically vesting (that is, becoming non-forfeitable) over a number of years. Currently, an employee can contribute up to $16,500 yearly or up to $22,000 for those age 50 or older, and combined employer and employee contributions are limited to $49,000 a year (or $54,500 for those 50 or older).

A 401(k) can also be deployed as a Safe Harbor 401(k), which has mandatory and fully vested matching provisions. Over the last five to six years the most popular version of this has been the enhanced Safe Harbor, which provides for a 100% match up to 4% of the employee's salary. Unlike the Traditional 401(k), the Safe Harbor does not require the various types of testing (nondiscrimination testing, top-heavy testing, and average deferral percentage or ADP testing) that limits the amount the owner can personally put away each year. There is also a type of 401(k) known as a SIMPLE 401(k): A counterpart to the SIMPLE IRA, it has no testing requirements and makes it easier for participants to borrow from their accounts, but it requires immediate vesting and has lower contribution limits. However, the SIMPLE 401(k) is rarely used any more as the Safe Harbor 401(k) is a much better alternative.

Finally, a business owner can check a box on their adoption agreement and add a Roth feature to their 401(k) plan. This Roth feature is similar to a Roth IRA for a self-employed individual in that it entails post-tax contributions, and therefore allows for tax-free growth and ultimately distribution in certain circumstances. Although a 401(k) with a Roth feature combine some of the best advantages of both 401(k)s and Roth IRAs, employers have been slow to make use of them, in part because of the perceived costs of having any kind of 401(k) plan. Fortunately, the price of 401(k) platforms generally has come down considerably, and one major provider offers a 401(k) plan with Form 5500 filing capabilities for as little as $250 a year.

Matching and Profit Sharing Perspectives

Depending on the type of retirement plan you as an employer choose to offer, you may have an annual decision as to what level of matching to offer, in addition to deciding whether to offer any profit sharing above and beyond the retirement plan. In both of these situations, a financial professional can help you balance and weigh a number of factors:

• The actual additional after-tax financial burden on the business (since matches and profit sharing are typically tax deductible)
• The financial (and therefore job satisfaction) benefit to current employees
• The ability to draw and retain top-notch employees
• The ability for you as the employer to max out contributions for your own retirement fund

Consider, for example, the case where an employer's accountant tells him that his company has made a $100,000 profit in a given year. Now, if none of that is distributed through profit sharing, then at a 35% federal and 9% state tax rate, nearly half of that money will simply disappear. Alternatively, this employer could distribute 75% of that money to himself and the other 25% to his employees as profit sharing, a scenario that results in both the employer and the employees being substantially better off.Now, suppose instead that the employer distributes 90% of that money to himself and only 10% to his employees. While some might say it's inappropriate for the owner to keep 90% of these distributed profits, on the other hand, it's really 100% of the owner's money in the first place, and there's no requirement to further distribute any of it to anyone, so really, the employees have no “right” to complain.

The point, however, is that there is no one “right” way for an employer to decide how much profit sharing to do, or how much to match (if there is a choice), or which kind of retirement plan to offer, or whether to offer one at all in the first place. Instead, there are many possibilities and complexities—this short article only scratched the surface of the details—and many different ways of coming up with the “right” plan for the unique situation that you, as a business owner, find yourself in. By working with an experienced financial professional, you can make the best decisions as to which plan to offer and how to customize it to your situation, and in the follow-up article the ways in which a financial professional can help you better deploy and maintain your plan will be considered.