Retirement Plans 101

Date: March 28, 2008

It's a smart move to offer some kind of retirement plan: You get a tax deduction, and it helps you attract and retain employees.

Small Business Retirement SolutionsGone are the days when a competitive salary was enough to lure top candidates to a job. Today’s lifestyle and financial concerns mean workers look to their employers to subsidize related benefits—particularly their retirements. A 2006 Prudential survey found that 86 percent of employees at U.S. businesses with at least 50 full-time employees were worried about saving for retirement, which topped the list of financial concerns.

“It’s a smart move to offer some kind of retirement plan: You get a tax deduction, and it helps you attract and retain employees,” says Jean D. Sifleet, a business lawyer and author of Beyond 401(k)s for Small Business Owners: A Practical Guide to Incentive, Deferred Compensation and Retirement Plans (Wiley, 2003).

But choosing the right retirement plan for your workers can be a daunting task. Options abound for helping your employees save for their retirement, and finding the right one requires a host of new vocabulary words—if not a new language. Here’s a look at the most common types of retirement plans:

Employer-funded SEP IRA (Simplified Employee Pension Plan)
How it works: Open to all businesses; funded by tax-deductible employer contributions. Vesting is immediate.
Level of involvement: Easy and inexpensive.
Pros: Easy to open and maintain.
Cons: Employees cannot contribute.
Works best for: Startups.

Simple IRA (Savings Incentive Match Plan for Employees)
How it works: Requires employers to match up to 3 percent of an employee’s salary.
Level of involvement: Easy and inexpensive.
Pros: Employees can contribute.
Cons: Mandatory match.
Works best for: Growing businesses.

How it works: Employees make pre-tax contributions; employers can choose to match.
Level of involvement: Moderate.
Pros: Employees contribute, open to all businesses.
Cons: Can be expensive to administer, though competition is driving costs down.
Works best for: Established, profitable companies.

Profit sharing
How it works: Allows employees to share in the company’s profits.
Level of involvement: Moderate.
Pros: Doubles as employee motivator; contributions vary each year.
Cons: Employees cannot contribute; can be expensive to set up and maintain.
Works best for: Established, profitable companies.

Defined benefits
How it works: An old-fashioned pension model where the retirement payout is defined upon establishing the plan based on fixed criteria—usually salary and length of service.
Level of involvement: Expensive and complicated.
Pros: Allows the business owner to sock away $185,000 annually, or 100 percent of average salary for three highest-paying years.
Cons: Employees cannot contribute or control investments; expensive and complicated to maintain.
Works best for: Business owners nearing retirement with a young workforce.

What about ROTH 401(k)? Read: Is the Roth 401(k) Retirement Plan Right for Your Company?

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