As you are no doubt aware, personal tax returns are due on Tuesday, April 18th. And we are definitely fairly busy this week as we wrap things up with certain clients, and ensure that everything is as excellent as it can possibly be — the right deductions, the right asset characterizations, depreciations, etc.
So THIS week might not be the best time to have this conversation for me and my staff, but I’m also aware that the world doesn’t revolve around us, and I would like to plant a seed. I’ve had this article kicking around for a while, and it might be the right time for YOU to start thinking about this.
You see, adding a company retirement plan can be an exciting milestone for any small business owner, but it is something with which to proceed with awareness.
What many commissioned sales people may not tell you is that increased compliance measures have added complexity and costs to managing these plans, and jumping to offer this benefit prematurely can drain both the coffers and the essential energy required to lift a small business from survival to profitability.
Having seen the fruits of these plans in our work, and also working with company owners in their succession planning, I’ve seen some stinkers and I’ve also seen a bunch of really smart plans.
Here are some dynamics you should keep in mind before establishing a new retirement plan…
James Eggers’ Three Important Qualifiers for a Company Retirement Plan
“If your actions inspire others to dream more, learn more, do more and become more, you are a leader.” -John Quincy Adams
Let’s dive right into this…
1. Your company budget matters.
Despite what a commission-based salesperson for a retirement plan might tell you, reducing your personal tax burden is not enough of an incentive to institute a company-wide retirement plan. A successful plan will also promote employee satisfaction and will enhance productivity.
Don’t even think of adding a retirement plan before your San Francisco Bay Area business can afford regular contributions to all employees. Plans that are poorly funded or lack a matching contribution receive very little support from the employees, and the costs quickly outweigh the perceived benefits.
I recommend considering 3% of all wages to be a minimum employer contribution before embarking on a retirement plan. Any less will lose you more credibility than not having a plan at all. In addition to a fixed contribution, these plans also allow a business to offer tax-sheltered profit sharing (bonuses) during the financially healthy years.
A good gauge of company health is to calculate your total employee payroll and benefits as a percentage of business revenue. These ratios will differ based on the type of business that you are in. Low-overhead professional businesses (accounting, financial planning, law practices) can sustainably target a 50% ratio, but any more is likely unsustainable over long periods. You should research successful businesses in your industry to find the right targets.
It will be helpful to begin this process of starting a new company retirement plan with a budgeted amount in mind of how much you can afford.
2. What is the BEST type of plan for YOU?
Most businesses implement 401(k) plans, but for small to midsized businesses, Savings Incentive Match Plans for Employees (SIMPLEs) and Simplified Employee Pension (SEP) IRAs are cost-effective alternatives. Regardless of the plan, employer contributions are deductible and avoid payroll taxes. These tax savings allow you to stretch your compensation dollars more than they otherwise would as a part of wages.
The 401(k) plans are the most common because they offer the most flexibility. You can create a plan that emphasizes contributions to those who have served the longest. You can set vesting schedules as long as six years, which will encourage employees to stick around.
These 401(k) plans also offer the ability to save in a Roth option without income limitations. I don’t recommend offering loans in your plan, but this is another option.
For most companies, their first 401(k) should be a Safe Harbor 401(k) plan. This will mandate either a 3% contribution to all eligible participants or a matching program. The benefits for this plan include reduced compliance costs because the Safe Harbor 401(k) plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401(k) plans.
Other companies may choose a SEP or SIMPLE IRA plan to avoid the need to hire a third-party administrator (TPA) and other burdens of a 401(k) plan. SEP plans work best for those companies that do not want to take on the administration of allowing employee contributions. A helpful comparison of the basic retirement plans can be found here: http://www.401khelpcenter.com/pdf/retirement_plan_comparison.pdf .
And remember: we can help you make sure that you are selecting the most tax-advantageous plan. That’s what we’re here for.
3. The investment strategy.
Too many start-up retirement funds perform poorly because they invest in high-cost funds offered by a commissioned salesperson. Avoid dealing with a go-between to oversee the plan until you have enough assets in the plan to justify high-quality service.
Many cost-conscious employers start their first retirement plan with prepackaged plans offered by large mutual fund companies. These companies offer target date retirement funds that make diversification easy. And these companies usually have a retirement specialist division that will help you set up these plans, but you will have to take care of much of the employee communication. There are other, more involved fiduciary options, as well, but that’s usually handled by a representative.
With the right timing, right plan and right investments, your company retirement plan really can be a huge success.
But do think it through.
And of course, as you know, none of my thoughts for you here should be construed as individual financial or legal advice, and I’m not endorsing any of the funds or options mentioned here over any others for your specific situation. But I do hope this is helpful for thinking these things through in your business, and for when you do meet with us or a qualified advisor about it all.
Eggers & Eggers of Silicon Valley