The Focus - Our Tax E-Newsletter |
Choosing and Maintaining the Right Retirement Plan
Experts estimate that Americans will need to receive 70 - 90% of their preretirement income during retirement, in order to be able to truly retire and be happy. Social Security most likely will not be enough to cover this on its own. Therefore, it is important to have another means of saving for retirement. If you already have a retirement plan in place, this is a good time to review the comparison table below to confirm the plan you originally established is still the correct fit for your business. If you do not have a retirement plan in place, now is the time to establish a plan to help you and your employees achieve retirement saving goals. Establishing a plan has numerous advantages including:
1.) Pre-tax Contributions – the ability to defer tax on current income to save towards retirement
2.) Tax Benefits - employer contributions made to a plan are deductible as a business expense
3.) Tax Benefits – a federal income tax credit to low and moderate income taxpayers who invest in a retirement plan
4.) Recruitment Tool - offering a retirement plan is a means of attracting and retaining key employees
There are many different types of retirement plans. Understanding the differences between the plans and what they offer is important. It is important to select and maintain a plan that matches your personal and business needs. In order to decide what plan is right, some questions you should ask yourself are:
1.) How much am I able to save for retirement?
2.) How many employees do I have?
3.) Do I want my employees to be able to contribute some of their own money?
4.) Is my business in a position to make contributions for my employees?
The answers to these questions will help guide you in selecting the plan that is right for you. Below is a comparison of the most common types of retirement plans:
|
Type of Plan |
IRA |
SEP |
SIMPLE |
401(k) |
|
Cost to establish |
Minimal |
Minimal* |
Minimal* |
Costlier* |
|
Who is eligible |
All |
Any employee who has worked in 3 of the past 5 years |
Any employee who has earned at least $5,000 during any 2 preceding years and expected to earn this in the current year |
Flexible – Can set age and service requirements of up to one year |
|
Who contributes |
Employee |
Employer |
Employee & Employer |
Employee & Employer |
|
Employee Contribution Limits** |
$6,000 maximum (Extra $1,000 catch up allowed if 50 and over) |
NA |
$13,500 (Extra $3,000 catch up allowed if 50 and over) |
$19,500 (Extra $6,500 catch up allowed if 50 and over) |
|
Employer Contribution Limits** |
NA |
Discretionary – Profit Sharing Up to 25% of compensation – maximum compensation of $285,000 for 2020 with maximum contribution of $57,000 |
Mandatory – must commit to either a 2% of pay to all eligible employees or up to a 3% matching contribution to those employees that defer |
Discretionary/Flexible – Up to 25% of compensation, maximum compensation of $285,000 for 2020 with maximum contribution of $57,000. Can offer a match or a profit sharing(or both) |
|
Time to Establish |
Any time – but contributions can only be deducted if made prior to original due date of tax return |
Can be set up as late as the due date of the business tax return |
Needs to be established prior to October 1st |
Anytime – unless a Safe Harbor 401(k) which needs to be established prior to October 1st |
*There is a tax credit for small employers that enables them to claim a credit on their tax return for part of the ordinary and necessary costs of starting an employer sponsored retirement plan equal to 50% of the cost up to $500 per year for the first three years.
**Limits above reflect 2020 amounts. The IRS releases retirement plan limits on an annual basis. For a more detailed chart that provides limits for 2018, 2019 and 2020, please click here.
As you can see there are many differences between the plans above. There are advantages and disadvantages to each. Selecting the right plan takes careful consideration and is dependent upon your business and personal retirement goals. If you have questions relating to the different types of retirement plans, or would like to discuss your options, please feel free to contact someone in our Retirement Plan Design and Administration Group at Dermody, Burke & Brown.
The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.