The Right Retirement Plan for Your Business

Are you a business owner setting up a retirement plan for yourself and your employees? The law gives you a lot of attractive options.

• SIMPLE (Savings Incentive Match Plans for Employees) and SEP (Simplified Employee Pension) are statutory plans, which means their requirements are established specifically by the Internal Revenue Code.
• Profit Sharing, 401(k), and Money Purchase Pension, are forms of defined contribution plans, where you (and your employees) put in a certain percentage of income, but benefits depend on how the investments you and they make with this money work.
• The final category is defined benefit plans, which pay you and your employees a certain amount depending on the number of years worked. These are the traditional pension plans of big corporations and government. They're not as common in small businesses, but they're an option too.

Here's a quick idea of the smorgasbord of possibilities. With a little effort, you'll find something that's right for you - but don't make that decision alone. You'd be well advised to consult your attorney with retirement planning experience. This is one of those times when expertise really pays off.

Statutory Plans

The statutory plans have little flexibility, since the law specifies their eligibility and vesting requirements.

• SEP. A SEP allows you to contribute to an IRA for each of your employees. You do not have to make a contribution to the plan every year.
• SIMPLE. If you go the SIMPLE route, you can adopt the plan as an IRA or as a 401(k) (a type of defined contribution plan that's available as a separate option). One bad part of SIMPLE plans is that you have to contribute to them every year regardless of your financial success for that year. (There are two types of SIMPLE plans, and one lets you reduce your contribution to 1% of payroll if you have a bad financial year and have chosen to adopt a SIMPLE IRA.) If you choose to set up a SIMPLE IRA, funds are held in an IRA, while the funds contributed to a 401(k) are held in a qualified trust.

A possible problem is that may part-time and seasonal workers will be eligible under the statutory plans. With defined contribution or defined benefit plans, you can focus coverage on employees more central to your business's success.

In choosing a plan, remember that you are employer and employee.

One more problem is that, with the SIMPLE and SEP, any contributions made to the plan are 100% vested, meaning that the employee is entitled to receive 100% of the funds in his or her account regardless of length of service with your business.

With defined contribution and defined benefit plans, on the other hand, you can establish a schedule so that your employees may become gradually vested in their accounts over a period of years. This encourages employees to stay with you, and rewards employees who've been with the company longer.

Defined Contribution Plans

Besides their vesting and eligibility flexibility, these plans are attractive to small businesses because they are inexpensive and easy to administer. With a defined contribution plan you must keep a separate account within a qualified trust for each individual employee, so that at any time the employee may know the account balance in his or her account. Defined contribution plans are easy to "sell" to employees because they can see how much money they have in their individual accounts. However, because of this account segregation, the investment risk falls on the employee.

Profit sharing plans and money purchase pension plans are types of defined contribution plans.

• Profit Sharing Plan. With a profit sharing plan, you make a yearly contribution to the plan to be allocated to the employees based on their compensation for the year. If you have a bad financial year, you will not have to make a contribution to the plan. Of course, since you're an employee too, you're also eligible to participate in the plan, and your share of the profit sharing would depend on what percentage of the payroll your contribution was. For example, if your payroll was $100,000 and you made $50,000, you would be entitled to 50% of the profit-sharing contribution. If you (the business) contributed $10,000 to profit sharing that year, you (the employee) would be entitled to $5,000.
• Money Purchase Pension Plan. By contrast, if you elect a money purchase pension plan, you will make a fixed percentage contribution each year. If you choose to make a 3% contribution it will be 3% of compensation to all employees. For example, if you made $50,000 during the year, you would receive $1,500.

Defined Benefit Plans

A defined benefit plan is just like it says. In a defined contribution plan, the employer defines the amount of contribution it will make each year, but in a defined benefit plan, the ultimate benefit the employee will receive on retirement is stated. An actuarial calculation has to be made to determine the amount the employer must contribute today in order for the employee to receive that stated amount on retirement. Because of this setup, the investment risk falls on the employer and not the employees. Because of the calculation, a defined benefit plan is more expensive to administer.

Also, benefits in a defined benefit plan are guaranteed. The employer pays an insurance premium to the Pension Benefit Guarantee Corporation (PBGC), which insures the funds in the plan at a certain level. If the plan or the employer goes belly up, the employees will be entitled to receive payments from the PBGC, though not their full entitlement.