Marc Ang gives a bird’s eye view of retirement plan options out there for businesses. It is important to start the discussion off knowing which questions to ask yourself and your business before you put something in place.
The time has finally come for you as a business owner.
Perhaps you’re getting sick and tired of the constant turnover and the A.D.D. nature of the workforce? Or you know that you have productive employees that have become such an important part of the business, you would like to minimize odds of them leaving.
It’s time for a retirement plan but the choices can be overwhelming.
There will be subsequent posts and resources such as a quiz or questionnaire to help you come to the right decision. But the scope of this article will be the following:
- For-profit companies. The additional options for non-profit companies include 403(b)s and 457s which are worth a separate discussion.
- A bird’s eye view/lay of the land on the options out there.
- To identify the right questions, allowing you to gather clarity around.
So let’s first talk about the 4 major types of retirement plan out there:
- Individual Retirement Arrangement (IRA)
- Defined Contribution
- Defined Benefit
- Equity Compensation
There are many options under these three categories, so we will talk about these with a very broad brush.
Individual Retirement Arrangement (IRA)
An Individual Retirement Arrangement (IRA) is appropriate for those employers who want to contribute something to their employees’ retirement. It is discretionary for the most part (except for rules under the SIMPLE IRA, if that’s the route that is chosen). Contribution limits are also low annually for the employee. $5,500 to $6,500 for the Payroll Deduction IRAs or SEPs, and $12,500 for SIMPLE.
Different Flavors: Payroll Deduction IRA, SEP, SIMPLE
Advantages: Low paperwork requirements, low administrative cost, simple and discretionary (on what the employer wants to give)
Disadvantages: No creditor protection with IRAs, No ability to take loans, lower contribution limits (for employee), less tax deductible upside for employer/company
Defined Contribution (i.e. 401(k))
Defined contribution plans (the most popular being a 401(k)) are generally plans where the employer contributes to retirement, but the investment risk lays with the employee (participants). While defined contribution plans require more administration and fees to maintain, the upside features may be worth the cost, as they create a “golden handcuffs” situation, influencing less turnover. Contribution limits are much higher ($53,000 per participant subject to rules), employees can take out loans and employer contributions can vest over time (up to 7 years), incentivizing employees to stay.
Different Flavors: 401(k), Profit Sharing, Safe Harbor, Money Purchase Pension, Target Benefit Pension
Advantages: Ability for employees to take out loans, higher contribution limits, vesting schedules. Safe harbor plans allow highly compensated employees to defer more and not be limited by the discrimination testing (but are also more costly)
Disadvantages: Higher paperwork and reporting requirements with increased costs, stricter testing and rules (must ensure no discrimination to highly compensated employees or by age)
Defined Benefit (Pension)
The traditional pension is what most people think of when they think of their employer contributing to retirement. Though they are becoming less and less popular, there are different flavors of defined benefit plans which may make sense for your business. The key feature is the ability to contribute (and hence, defer) a higher amount of income than a defined contribution plan can. It is also more valued by employees, who don’t need to contribute anything and will still get the fixed benefit.
Different Flavors: Defined Benefit Pension, Cash Balance Pension
Advantages: Forfeitures stay with employer, employees prefer these to a defined contribution plan, higher deferral limits to hypercharge employer’s retirement
Ability for employees to take out loans, higher contribution limits, vesting schedules. Safe harbor plans allow highly compensated employees to defer more and not be limited by the discrimination testing (but are also more costly)
Disadvantages: Investment risk falls on employer, requires an actuary every year, more administrative costs
In a separate discussion, we will cover equity compensation. Equity compensation plans are appropriate for many start-up companies who anticipate a large infusion of cash down the line. The major types include:
- Stock Bonus Plan
- Stock Options
Please visit our post to learn more about equity compensation.
Questions to Ask Yourself
- What type of vesting schedule would you like? 100% available to the employee when they leave, or would you like barriers along the way? (i.e. a 3 year cliff vest, or a 7 year gradual vesting schedule)
- Can you as a business honor a fixed contribution every year or would you rather contribute on a discretionary basis? Or do you have cash flow worries?
- What are your concerns about fees?
- Do you as a company want to take the investment risk or do you want to pass it onto your employees?
- What is the realistic likelihood of your employees participating and contributing, and to what extent?
- Is the need to incentivize for key employees higher than another subset of employees on the lower levels that you don’t mind leaving?
- How much do you as an employer want to defer on an annual basis?
These questions can go a long way to narrowing down the many options for retirement plans out there, and find the one that is most suitable to you.
Marc Ang (Mangus) is a financial planner based in Claremont, CA, focused on spreading the gospel about responsible, educated and smart financial planning.