By Chad Parks
In my initial article for Retirement Daily, I discussed key points for small business owners to keep in mind when offering a retirement plan, including the associated costs, variety of investments available, flexibility of plan design and quality of customer service. As a follow-up to that primer, I’ll now dive into greater detail about the resources available to help you become better informed, as well as the different types of plans a small business owner might consider.
Who Can Help
As you contemplate instituting a plan, it’s natural to wonder where you might turn for more information. One of the first sources I suggest consulting is your payroll company. For example, do they have a 401(k) plan or partner with a 401(k) provider? What kind of integration do they offer between the payroll system and the 401(k) company? Would such an integration make establishing a plan easier for you?
Next, I recommend speaking with your benefits broker. Do they have relationships with any 401(k) vendors? Since a 401(k) plan is considered a benefit, the employees in your small business who coordinate benefits would typically also manage a 401(k) relationship.
Another option is to speak with your financial advisor. Some advisors who are well versed in small business retirement plans could potentially suggest a plan they’ve worked with before and help bring it to fruition for you.
Finally, I encourage small business owners to pour through the treasure trove of information on the internet. You could start by simply typing “small business retirement plans” or “small business 401(k)” into a search engine. It’s important to become familiar with the various online providers because they will most likely offer different solutions than traditional payroll companies or benefits brokers.
After discovering what appeals to you on these sites, engage companies directly. There’s no obligation following an introductory conversation with a representative, and it could provide a great free education. As my previous article notes, it’s good to bring specific questions to the table, such as “What services are being provided?” and “Who is managing the investments?”
Additionally, I recommend finding out how the plan provider is being paid and evaluating the fees associated with different plan offerings. It’s also important to learn if the person or entity managing the investments has a fiduciary responsibility to act in your best interest, which includes monitoring the fees to ensure they remain low.
I must admit our industry is filled with complicated jargon that might prove difficult to grasp at first. Having discussions with plan provider representatives can help you better understand the terminology, as well as which products or plan designs would best suit your small business.
SIMPLE IRA versus 401(k)
One choice you’ll almost certainly face is whether to select a SIMPLE IRA (Savings Incentive Match Plan for Employees) or a 401(k), which have subtle but important differences between them. SIMPLEs tend to charge lower initial and ongoing costs, but typically don’t offer all the features of a 401(k).
To determine which would be better for your business, there are a few helpful questions to ponder. For instance, do you and your employees want to save the greatest amount possible up to the annual legal limit? That cap is currently $19,500 for a 401(k) and $26,000 if you’re at least 50. Alternatively, the limit for a SIMPLE is $13,500. If being able to save additional money each year is a priority, the 401(k) offers a clear advantage.
Another consideration is whether you want to be responsible for an employer match. With a SIMPLE, a match is mandatory even if an employee isn’t participating in the plan. That’s a notable distinction, because matches are optional for 401(k) plans.
If you’re on board with an employer match, another aspect to evaluate is the safe harbor match offered by some 401(k) plans. The basic version of this provision states that employees must contribute to the 401(k) to qualify for a match, with the employer then matching 100% of the first 3% of each employee’s contribution and 50% of the next 2%. As a result, you and your highly compensated employees would be virtually guaranteed to max out annual contributions.
Finally, administrative costs should be considered. Although there may be a misconception that SIMPLEs don’t come with these expenses, the reality is most providers will charge a fee to run your plan. One of my favorite sayings about the subject is, “SIMPLE is an acronym, not an adjective.” In my experience, if you’ve done your research and feel ready to institute a retirement plan for your business, a 401(k) will often be the better option.
Traditional 401(k) versus Roth 401(k)
Within the context of a 401(k), you can also evaluate whether to offer both traditional and Roth contribution methods. From an individual personal tax situation, each has potential pros and cons. My rule of thumb is that the Roth method would likely be a better option if you’re 45 or younger, because although the money is taxed prior to your contribution, it will grow tax-free within the plan and avoid taxation upon withdrawal. You’d benefit from years of untaxed, compounded growth and essentially enjoy a substantial tax-free paycheck at whatever point you decide to receive it. As an employer, it’s best to offer both traditional and Roth plan options, and most providers should be able to do that at no additional cost. Then, let your employees decide what is best for them.
What you give up today with a Roth 401(k) is immediate tax savings. The reason I say it makes sense if you’re 45 or younger is that you’ll likely have 20-plus years of tax-deferred growth before retirement to overcome the initial loss inflicted by taxation. Conversely, a traditional contribution might make more sense if you’re over 45, because there would be less time to take advantage of the tax-free accumulation offered by the Roth method.
Although online calculators can help you compare the two options and decide if you’d be better off paying taxes now or later, there’s a wild card that makes any such calculations potentially flawed — future tax rates are unknown. Thus, different schools of thought exist about which selection might be better, and you could make a case for either or both.
In the end, what matters most when choosing a retirement plan for your small business is exercising appropriate due diligence. Speak with professionals you trust, conduct online research and call individual plan providers to learn what you’d be getting for your money.
I would caution against prioritizing convenience over a better overall option. Take your time and make the best decision. Although it might seem most convenient to just contract with your payroll company to provide a plan, for example, that doesn’t mean it will provide the greatest value.
Whatever option you choose, consider sharing your experience with other small business owners. Currently, only about 40% of small businesses offer a retirement plan. By discussing your findings and eventual selection with your peers, you might encourage them to institute plans for their businesses as well.
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