A retirement plan allows your employees to accumulate the savings they will need to retire. Plus, many types of retirement plans offer a significant tax savings for you, the employer. According to the Internal Revenue Service, most Americans will need 70-90 percent of their preretirement income to maintain their standard of living after they retire. As an employer, you can play a significant part in helping your workers achieve their retirement savings goals.
Different Types of Retirement Plans
A defined benefit plan provides employees with a monthly benefit in a specific dollar amount at retirement. The amount of the monthly benefit is usually calculated based on factors such as salary and length of employment with the company. These types of plans are entirely funded by you, the employer.
The other type of retirement benefit plan is a defined contribution plan. In these types of retirement plans, you or your employees (or both) contribute to individual retirement accounts for each participating employee. The contribution is often a percentage of the employee's salary up to a predetermined maximum amount, and contributions are made pre-tax. These contributions are invested on the employee's behalf, and the employee can withdraw from the balance of the account at retirement, minus investment losses. Defined contribution plans include 401(k) plans (and 403(b) plans for nonprofit organizations).
Stock ownership plans and profit-sharing plans are also considered defined contribution, or "qualified" plans. Under these types of plans, however, you as the employer will contribute to an employee's retirement account out of your company's annual profits or contribute a predetermined amount of company stock. Contributions vary depending on how profitable a year your business had.
There are also IRA-based retirement savings vehicles. A SIMPLE IRA plan is a choice if you have 100 or fewer employees. A SIMPLE plan allows you to set up an IRA for yourself and each of your employees. You are required to match employee contributions dollar for dollar (up to 3 percent of the employee's annual compensation) or contribute a fixed amount of 2 percent of each employee's compensation.
Another type of IRA-based retirement plan is a Simplified Employee Pension Plan (SEP). Employees and employers contribute to individual retirement accounts under an SEP, but an employee must have an Individual Retirement Account (IRA) set up to receive employer contributions. You contribute a set percentage of an employee's compensation annually under an SEP. But, the plan is flexible so you can skip contributions in years when business conditions make it unwise for you to contribute.
Remember: With SEPs and other IRA-based retirement plans, your employees immediately vest in, or own, the contributions you make to their accounts. With qualified plans, such as 401(k)s, you can require that employees work for you for a set number of years before they are completely "vested" in the plan and own employer contributions.
Note: Qualified plans such as 401(k)s, profit-sharing plans, and defined benefit plans are often more expensive and complex to maintain than IRA-based plans because they must comply with specific tax and Employee Retirement Income Security Act of 1974 (ERISA) regulations. Also, keep in mind that the assets associated with a qualified retirement plan must be held either in trust or by an insurance company.