September Focus: Five Tips on Choosing the Right Retirement Plan for Your Business

A small business owner who decides to adopt a retirement plan for her business has made only the first of many important steps in this direction. The next step is to decide which retirement plan would be suitable for the business. If you find yourself faced with such a dilemma, use the following tips to help you make the right decision:

Can You Afford to Fund the Plan Each Year?

If your business is new or your profits are cyclical, you may want to choose a retirement plan with a discretionary contribution feature. This includes SEP IRAs and profit sharing plans. The discretionary feature allows you to choose whether you want to fund the plan in a particular year. This can be a useful feature in cases where your business experiences a loss or you feel that your profits are not sufficient to allow for funding of the plan. Caution: With the profit sharing plan, you want to be careful about not funding the plan for too many consecutive years, as the IRS may determine that your plan is not eligible for the tax deductions and tax-deferred treatment afforded to employer sponsored plans.

A money purchase pension plan has a mandatory contribution feature, which requires that you fund the plan whether you can afford to or not. SIMPLE IRA contributions can also be mandatory, if you choose the nonelective contribution feature, or if you choose the matching contribution feature and your employees elect to make salary deferral contributions. Read about the challenges faced by business owners who adopt SIMPLE IRAs and get tips on how to avoid such dilemmas in the September 2009 issue of Ed Slott’s IRA Advisor.

Is the Cost of Maintenance a Concern?

The administrative costs of maintaining a retirement plan range from very low to very high. The least costly is the SEP IRA, because administration is usually limited to funding the plan and reporting contributions on your business’ tax return. The 401(k) plan is usually the most costly because of the nondiscrimination testing which is required. If administrative cost is an issue, work with your retirement counselor to identify the costs that may apply to each plan, and choose the one that you can afford to maintain.

Note: Defined benefit plans are usually more costly to maintain than 401(k) plans, but are beyond the scope of this article.

How Much do You Need to Save?

If you have a long period over which to accumulate your retirement nest egg, you have some degree of flexibility with respect to the type of retirement plan that you choose. However if you are close to retirement age and find that you have come up short of your savings goal, you may want to consider a retirement plan that allows to you skew contribution amounts so that the lion’s share goes to older employees, such as an age weighted profit sharing plan. Of course, this feature would be beneficial to you only if you are older than your employees.

Do You Want to Offer Loans?

If you would like your employees, including yourself and your spouse (if your spouse works for your business), to be able to take loans from your retirement plan, then you must choose a qualified plan. This is because SEP IRAs and SIMPLE IRAs cannot include loan features.

Do You Want to Place Restrictions on Withdrawals?

Many employers maintain retirement plans because they specifically want to help their employees save for their retirement. If the employees withdraw their account balances before retirement, it defeats the employer’s goal. If you want to place restrictions on when employees can withdraw their balances, you would need to adopt a qualified plan and implement those restrictions. In the case of SEP and SIMPLE IRAs, withdrawals are made at the employee’s discretion, which means they can be made at anytime.

Conclusion

There are many other features to consider when choosing a retirement plan for your business. For instance, a profit sharing plan can include a mandatory contribution feature. As such, you want to be careful when you choose the elective features for your retirement plan. Your retirement counselor can help you to define the retirement profile of your business and this will greatly assist you in choosing the most suitable retirement plan for yourself and your employees.

 Explanations of the rules that govern IRAs are usually provided in Ed Slott's IRA Advisor Newsletter. If you are not already a subscriber and want to get an idea of the content of the newsletter, you can preview past issues before subscribing.

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