How to Set Up a Retirement Plan for Your Small Business

Four Reasons Your Small Business Should Offer a Retirement Plan

Owning and operating a small business is anything but easy. There are budget constraints, deadlines to meet, and goals to hit. For small business owners running on razor-thin margins, there’s little room for discretionary spending. Fortunately, offering your employees a retirement plan isn’t just a charitable write-off—it has concrete financial benefits.

Hire and Retain Top Talent

Before the coronavirus pandemic, America’s unemployment rate was 3.5 percent. While that number has risen to 14.7 percent as a result of the pandemic, it won’t stay that way forever, and eventually you’ll be competing with other businesses to find and keep talented candidates. Plus, even during high unemployment, you still want to attract people who will stay with you through tough times rather than jump ship the minute a better offer comes along.

Businesses have to provide what candidates want to win top talent and build employee loyalty. And what employees want are more and better employee benefits. 57 percent of people report benefits and perks being a leading factor in considering a job, and 80 percent of employees claim they’d choose additional benefits instead of a pay raise.

But not all benefits are valued equally. While cereal bars and free parking are nice-to-haves, employees also have specific demands—like retirement help. Retirement is the third most desirable benefit, right after paid-time-off and health insurance.

A strong employer brand makes it easier to attract and retain high-quality talent, which reduces position vacancies and keeps your business operations running smoothly. It also decreases the amount of time and money you spend on recruiting and training new candidates, which can cost an estimated 4,000 dollars per employee.

Enjoy Tax Benefits

401(k) plans provide tax benefits to you, your employees, and your business—now and later. If you choose a traditional plan, you and your employee make pre-tax retirement contributions, meaning you save more with less. And when it comes time to ride off into that sweet retirement sunset, your withdrawn money is taxed at an income tax rate, not a capital gains tax rate, which means you keep a lot more cash.

While these are great benefits for you and your employees to enjoy in decades to come, you’ll also reap a few immediate fiscal rewards:

• Up to 5,000 dollars in tax credit per year for the first three years when you open your first business 401(k) plan
• Another 500 dollars in tax credit per year for the first three years, if your plan includes automatic enrollment
• Tax-deductible employee-matching 401(k) contributions
• Reduced personal tax obligation from the decrease in your taxable income

Ease Your Employees’ Financial Worries

On paper, it makes sense to start a business retirement plan, but it’s even more worthwhile from a human perspective. Money issues keep over half of Americans tossing and turning in bed at night. By relieving retirement stress, you’re helping employees sleep better, work better, and live better.

Offering a retirement plan is a win-win decision—not only does it allow you to help your employees further, but it also helps your business, as happy employees are more efficient employees. Studies show happiness can spike employee productivity by as much as 12 percent. In comparison, unhappy employees can become 10 percent less productive than the average.

Save for Your Retirement

Many entrepreneurs pour their blood, sweat, and tears into their company. While your business’s future is important, you can’t neglect your own future. One day, the business will go on without you, but you need to make sure you can go on without the business.

Setting up a business 401(k) helps you enjoy pre-tax and employee-matching contributions. As the owner, it can be hard enough to take a deposit out of your business’s profits for your salary. To make saving easier, set up automatic deposits, so you can set it and forget it.

Considerations When Choosing a Retirement Plan

Before you go out and choose a retirement plan, here are a few things to consider.

Cost

Small businesses should plan to spend 5,000 to 10,000 dollars a year for a traditional employer-sponsored 401(k). This cost includes 800 to 1,000 dollars in administrative fees, quarterly charges per participant, and other miscellaneous fees. Initial setup fees can range from 500 to 3,000 dollars. You’ll also need to decide if your company is going to match a certain percentage of employee contributions.

These figures might have your eyes popping, but remember that you’ll get to claim fantastic tax deductions. Plus, when you open your first business 401(k), you’ll receive up to 5,000 dollars in tax credit—that’s more than enough to cover the setup fees and get things rolling.

Ease of Use

Make sure you shop around and demo different products to judge their ease of use. You don’t want a distracting, clunky experience for you or your employees. The software should be straightforward and empower employees to take ownership of their retirement rather than sit idly on the sidelines.

Flexibility

There are a variety of retirement plans to choose from, and you’ll want to make sure yours provides the flexibility you and your employees need. For example, if you’re a solo entrepreneur, a solo 401(k) will allow you to contribute more than a traditional 401(k).

How to Set up a Retirement Plan for Your Business

If you’re convinced your small business needs to sponsor a retirement plan, then it’s time to set one up. Getting started is simple.

Step 1: Choose a Retirement Plan

When it comes to choosing the right retirement plan, there’s no shortage of options. There are several small business retirement plans, and each has its pros, cons, and requirements. Here are the nuances of the most common tax-deferred small business retirement plans.

Traditional 401(k) Plans

A traditional 401(k) is the most common kind of employer-sponsored retirement plan.

Why Choose a Traditional 401(k)

Employees love it because of the optional automatic payroll deductions, tax-deferred savings, and complete freedom over their contribution amounts and specific investments. Business owners love it because they get flexible control over eligibility requirements, vesting schedules, profit sharing, and matching. It’s also easier now more than ever to outsource the administrative work to a third-party service.

Practically any business can start a traditional 401(k), but nonprofits and solo entrepreneurs may benefit more from other plans.

Contribution Limits and Tax Benefits

The Internal Revenue Service (IRS) recently increased employee’s contributions limits from 19,000 to 19,500 dollars and also increased the catch-up contribution limit (for employees aged 50) from 6,000 to 6,500 dollars. On this plan, you’re also able to offer employee matching and profit sharing.

With a traditional 401(k), employees make contributions pre-tax. When employees withdraw the money in retirement, the IRS will tax the cash at a rate that’s much lower than it is while employees are still making money.

Compliance Requirements

Businesses need to meet three main requirements to be eligible for a traditional 401(k):

1. Create and run the retirement plan in the best interest of the employees—also known as a fiduciary duty.
2. Ensure all parties have equal opportunity to contribute by passing nondiscrimination tests.
3. Each year, small business owners need to file Form 5500 with the IRS/Department of Labor (DOL).

Safe Harbor 401(k) Plans

A Safe Harbor 401(k) is similar to the traditional 401(k), except employers don’t need to pass nondiscrimination tests. Small businesses can qualify for this retirement plan by committing to employee contribution matching.

Why Choose a Safe Harbor 401(k)

Nondiscrimination testing costs time and money. Bypassing these tests gives employers additional funds to match employee contributions, which are required if they choose this retirement plan.

Contribution Limits and Tax Benefits

Like with the traditional 401(k), employee contributions are capped at 19,500 dollars (25,500 dollars for employees 50 and older). However, employer matching doesn’t count towards the cap, allowing employees to save beyond that limit.

Employees make pre-tax contributions to their Safe Harbor 401(k), and small businesses receive credits and deductions come tax time.

Compliance Requirements

There are three primary requirements for offering a Safe Harbor 401(k):

1. The business still needs to perform its fiduciary duty.
2. Small business owners must file Form 5500.
3. Employers must meet one of the qualifying matching criteria:
   1. Basic match: employer provides a 100 percent match of the first 3 percent of employee contributions and 50 percent of the next 2 percent.
   2. Non-elective contribution: employer contributes at least 3 percent of each employee’s salary, regardless of whether they contribute.

Solo 401(k) Plans

Solo 401(k) plans offer all the primary benefits of a traditional 401(k) without all the compliance requirements. It’s the perfect retirement plan option for small business owners flying solo.

Why Choose a Solo 401(k)

Solo 401(k)s don’t have strict compliance requirements.

Contribution Limits and Tax Benefits

The employee contribution limit is 19,500 dollars, and the employer matching can’t exceed 25 percent of your salary. The highest amount you could save in a Solo 401(k) in a year is 56,000 percent.

Employees make pre-tax contributions, and withdrawals during retirement are taxed at a lower rate—not a capital gains tax rate.

Compliance Requirements

Fiduciary duty and nondiscrimination tests aren’t necessary, but you will still need to file a Form 5500-SF with the IRS/DOL each year.

Savings Incentive Match Plan for Employees (SIMPLE) IRA Plans

A SIMPLE IRA is similar to a Safe Harbor 401(k) in that there’s no nondiscrimination testing, but the contribution limits are lower.

Why Choose a SIMPLE IRA Plan

If you have fewer than 100 employees and want to bypass nondiscrimination testing, a SIMPLE IRA might be right for your business.

Contribution Limits and Tax Benefits

Employees can contribute up to 13,000 dollars annually (16,000 dollars for those 50 or older).

Employees make pre-tax contributions, and retirement withdrawals are taxed at a lower rate. Business owners can receive tax credits for sponsoring SIMPLE IRA plans.

Compliance Requirements

To qualify, you’ll need to match employee contributions in one of the following ways:

1. Match employee contributions up to 3 percent of their compensation
2. Contribute 2 percent of each employees’ compensation, regardless of whether they contribute.

Simplified Employee Pension (SEP) IRA Plans

Employers sponsor and fund SEP IRA plans. Businesses get to decide how much they’re going to contribute, and employees must enroll on their own to receive the benefit.

Why Choose a SEP IRA Plan

SEP IRA plans are great for smaller companies who want to contribute to their team’s retirement.

Contribution Limits and Tax Benefits

Employers can make contributions up to 56,000 dollars annually, but the contributions can’t exceed 25 percent of an employee’s compensation.

When employees withdraw the funds later, they’ll be taxed at the income tax rate. Businesses may claim contributions as business expenses when filing taxes.

Compliance Requirements

The only requirement is that businesses contribute the same percentage of employees’ compensation to all employees.

403(b) Plans

403(b) plans are similar to traditional 401(k) plans, but they have more relaxed compliance requirements.

Why Choose a 403(b)

Nonprofits and educational organizations are the only businesses that can offer 403(b) plans.

Contribution Limits and Tax Benefits

Contribution limits and tax benefits are the same as with a traditional 401(k).

Compliance Requirements

Like with the traditional 401(k), businesses must follow fiduciary duties, pass nondiscrimination testing, and file Form 5500.

Step 2: Find a Plan Provider and Administrator

Do your research to find a service provider who offers the retirement plan you’d like. Also, designate a plan administrator to manage your plan.

Step 3: Sign Up

Follow the plan administrator’s enrollment process.

Getting started is easy, and it’s never too late to set up a retirement plan for your business. Start investing in your employees’ future (and your own) as soon as you can to enjoy the benefits when you ride off into the sweet retirement sunset.

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Bio: Samantha Novick is a senior editor at Funding Circle, a global small business loans platform offering Small Business Administration 7(a) loans as an affordable solution to access the capital your business needs.