An employee retirement plan for small businesses is easier to establish and run than you may think. Employer contributions are generally tax-deductible, and you may qualify for a $500 tax credit for setting up a pension plan. In addition, small business retirement plans require less paperwork than traditional pension plans and may help to draw and retain employees.
While there are several employee retirement plans available, the following are well-suited to small businesses because they’re relatively low-cost, easy to set up and administer. Consult with your tax professional to ensure the plan you choose is suitable for your business profile.
Payroll Deduction IRA
The Internal Revenue Service calls this the "no fuss, no muss" employee retirement plan. Because it is the simplest retirement arrangement that a business can offer, it is especially well-suited to a small business with limited resources to devote to plan administration. Under this plan, an employer transfers pre-tax salary deductions to traditional or Roth individual retirement accounts that employees establish and manage. Business owners can place limitations on the number of accounts to which they’ll transfer funds.
Pros: The employer has little responsibility except to transfer the funds. There is almost no paperwork or administrative cost. Employee contributions are tax deferred up to $4,000 in 2007, with additional $1,000 catch-up contributions for employees 50 and older.
Cons: Employers do not get tax breaks. Employees may consider payroll deduction a perk, not a benefit, because employers are only transferring the money and do not contribute.
SEP IRA
Ideally suited to small businesses and the self-employed, simplified employee pension (SEP) IRAs offer your employees retirement savings plans that are tax-deductible for your business. As an employer, you are eligible to participate in the plan as well. The Small Business Administration praises this employee pension plan for its simplicity and flexibility.
Under a SEP IRA accounts are set up and managed by employees, but employers must establish a SEP plan for their business. You'll need to have written agreements with employees that comply with IRS standards; the IRS provides a model SEP agreement, as do many financial institutions. All you need to do after that is transfer the funds to your employees' banks or financial institutions, which will manage their IRAs. The first contribution needs to be made by the time your taxes are due, including extensions.
The contribution limit on SEPs is 25 percent of the employee's salary or $45,000 for 2007. If you do establish a SEP, it must be set up for each eligible employee, in accordance with eligibility requirements laid out in IRS rules. Eligible employees must be at least 21 and have worked for you for three of the last five years, but you can make your plan less restrictive. Union employees are generally not eligible. Employees do not pay taxes on SEP investments until they withdraw from their accounts.
Pros: SEP contributions are tax-deductible for employers. SEPs require little paperwork and are easy to administer. Employers determine how much to contribute, as long as the percentage of contributions is equal for all employees based on their income. As an employer, you can change contribution levels annually, including not contributing at all, and contribution ceilings are higher than other retirement schemes. Note, there are special rules governing the contributions made by the self-employed individual.
Cons: Employees cannot contribute themselves, nor can they decide when or how much their employers will put into their retirement funds. As with other IRA plans, employees wanting to make an early withdrawal will pay income taxes on the withdrawal and will probably be hit with a 10 percent fine.
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