With a tightening job market, a 401(k) and its iterations can help give business owners a leg up.
In a candidate-driven job market, competitive retirement plans continue to be in high demand. You may know quite a bit about 401(k) profit-sharing plans specifically, but their iterations – the solopreneur or one-person plan, the safe harbor plan and the SIMPLE plan – could give your business a leg up as well. Let’s dig in.
The 401(k) is the bedrock of retirement planning. Simply put, this is a profit-sharing retirement plan that allows employees to make elective salary deferrals and avoid present-day taxes on that portion of their income. Most employers, including not-for-profit organizations, can offer a 401(k) plan to their employees. The exception here is any government entity.
In addition, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) allowed employees to add qualified Roth contributions to their 401(k) plans; however, the Roth 401(k) contributions only apply to employees’ elective salary deferrals. And since it is a Roth vehicle, the contributions are after-tax, not pre-tax like the typical 401(k).
This retirement savings plan can work well for individuals who are sole operators of their businesses. It can also work for those who share ownership and responsibility with family members or with partners, with the caveat being that those individuals must each own at least 5% of the business. The owners-only 401(k) is available to business entities including sole proprietorships and partnerships, as well as C, S and limited liability corporations.
A safe harbor 401(k) plan is similar to a traditional 401(k). But it has one key benefit: low employee participation doesn’t keep the business owner from achieving the maximum pre-tax payroll deferral limit. But do note that the company must be willing to make contributions on behalf of its employees.
A SIMPLE plan provides for elective salary reduction contributions (deferrals) by eligible employees up to $13,500 for 2021 (or 100% of compensation, whichever is less). The plan also requires a mandatory contribution by the employer that is either a dollar-for-dollar match of up to 3% of compensation (can go as low as 1% in two out of five rolling calendar years) or a nonelective amount of 2% to eligible employees, whether an employee participates in the plan or not. The employer cannot make any additional contributions and may not sponsor any other retirement plan in conjunction with a SIMPLE plan.
For what may be considered a tradeoff to this mandatory contribution, the good news is that there are minimal tax filing requirements, no nondiscrimination tests and no top-heavy contributions required by the employer. These provisions allow any employee, including a highly compensated one, to defer up to $13,500 (2021) without any consideration to any deferrals made by other employees.
Catch-up contributions are allowed in SIMPLE plans for qualified individuals. The contribution is in addition to the regular salary reduction contribution and the match or nonelective contribution. This additional contribution is $3,000 for 2021 and will be indexed for inflation thereafter.
Choosing a plan requires a careful look at your current plan if you have one, your employee demographics, overall company goals –growth, retaining talent or otherwise – and at how each plan aligns with those.
Your advisor can help guide you through the pros and cons of each and connect you with specialized fiduciaries who can oversee any administrative and legal responsibilities involved.
Sources: humaninterest.com; employeefiduciary.com; nerdwallet.com; money.usnews.com
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Investors should consider their personal investment horizon and income tax brackets, both current and anticipated, when making an investment decision, as these may further impact the results of the comparisons. Keep in mind that results will vary as investing involves risk, fluctuating returns and the possibility of loss.