Is Your Retirement Plan Right for You?
There are seemingly endless options when it comes to picking a retirement plan that is best for yourself and your business. And there is much nuance to the differences between each type of plan.
With that nuance comes room for customization and flexibility, but it also leaves room for confusion and error when embarked on without guidance.
For the sake of brevity, some of the most popular types of plans are covered here, corresponding with common situations business owners and the self-employed find themselves in.
To understand most completely which plan is right for you, seek advice from a professional advisory team that is well-versed in retirement plan management.
I own a small business or practice and want to provide a benefit to both myself and my employees. Which retirement plan makes sense?
Commonly in this scenario, the business owner and/or company leadership are more highly compensated than their employees. This can present an issue with some types of plans if the employer wants to maximize his own contributions.
The IRS recognized this issue and provided different plans to allow for business owners to contribute higher amounts while also providing a plan for employees. Two common options for this scenario are using either a Simple IRA or a Safe Harbor 401(k).
These plans are similar in that they both have some type of mandatory employer match or contribution and the employer portion is immediately vested for the participant. Both plans have specific rules and do not allow for much deviation or customization from the structure.
There are differences between the two types of retirement plans. But one of the significant disparities is in the amount participants can contribute.
The Safe Harbor 401(k) allows for much higher contribution maximums ($19,500 with an additional $6,500 catch-up for those over 50; this does not include profit sharing) whereas Simple IRAs have a $13,500 maximum plus a $3,000 catch-up.
Both plans have the option of either a nonelective contribution, meaning every eligible participant gets an employer contribution based on salary, or a match, meaning the participant must contribute his own money to get any employer contributions. Safe Harbor 401(k) non-elective contributions and matches are slightly higher than that of a Simple IRA.
Safe Harbor 401(k)s also generally have additional administrative expenses, like hiring a third-party administrator for reporting, that make them more expensive and more involved than a Simple IRA. If desired funding levels are lower than the maximums allowed in a Safe Harbor 401(k), you may consider a Simple IRA.
Simple IRAs also have lower eligibility rules, making the plan open to more employees. Simple IRAs do not allow for Roth contributions. So you will want to take this into consideration as well.
I have a larger company or I anticipate rapid growth and increased employee capacity in the future. What are my best options?
This situation may have the most nuance among the ones presented here.
Many larger or growing companies want to provide a retirement plan to attract talent at all levels. You may consider including built-in incentives for key or more managerial employees to increase profit and reap the benefits in their retirement accounts.
You may want these incentives to not be immediately available to encourage employees to stay with your company. You may even be looking at some type of defined benefit or pension plan.
The beauty is that there are many options to custom tailor your plan to your business’ goals. But this must be done in close coordination with retirement plan experts and requires diligent ongoing maintenance.
What plan should I use if I am self-employed?
Since self-employed folks do not have employees to consider when deciding which plan to use, the answer to this question mostly comes down to how much you want to tuck away for retirement and what type of contribution you wish to use.
For example, a high-earning self-employed individual who is close to retirement may benefit from using a solo 401(k), which allows for the contribution maximums and would provide the biggest immediate tax benefit.
In some cases, you can put $58,000 into a solo 401(k) as well as contributing a similar amount for a spouse into the plan. 401(k)s may come with additional administrative reporting and expenses, such as payment for using a third-party administrator.
Generally, the maximum contribution limits for self-employed plans are greatest on solo 401(k)s and SEP IRAs versus Simple IRAs and traditional IRAs or Roth IRAs.
All these plans allow for pre-tax contributions except a Roth IRA. Solo 401(k)s and Roth IRAs allow Roth contributions.
Again, careful consideration should be taken in identifying which type of contribution will maximize your financial position.
What is the difference between pre-tax contributions and Roth contributions?
Pre-tax contributions are deferred into a retirement plan before taxes are taken out, grow tax-deferred, and are finally taxed when they are withdrawn in retirement. Roth contributions are taxed before they go into the retirement plan, grow tax-free, and are not taxable when they are withdrawn in retirement.
Money that goes into a plan on a pre-tax basis will also eventually be subject to RMDs, or required minimum distributions, at age 72. These are the rules as they generally stand but may change slightly depending on the scenario.
It is important to first understand the difference between these types of contributions because different retirement plans may allow for one, the other, or both.
The type of contribution that is appropriate for you may depend on your age, current tax rates, estimated future tax rates, time until you start withdrawing, goals and more.
The retirement planning realm has a breadth of options with a few being touched on above.
Understanding the laws and structure of retirement plans requires expertise and unwinding a plan can be costly and painstaking.
Working with a retirement planning professional can help to ensure the plans that do not work for you are rooted out and the ones that do are presented to you.
Any plan will require ongoing maintenance and observation, some requiring more than others.
Using the right professional in this space can be a true asset to your business, your personal financial life and your employees.
Fee-Based Planning offered through W3 Wealth Advisors, LLC – a State Registered Investment Adviser – Third Party Money Management offered through Valmark Advisers, Inc. a SEC Registered Investment Adviser – Securities offered through Valmark Securities, Inc. Member FINRA, SIPC – 130 Springside Drive, Suite 300 Akron, Ohio 44333-2431 * 1-800-765-5201 – W3 Wealth Management, LLC and W3 Wealth Advisors, LLC are separate entities from Valmark Securities Inc. and Valmark Advisers Inc.
The example(s) given are hypothetical and are for illustrative purposes. Actual results may vary from those illustrated
This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The services of an appropriate professional should be sought regarding your individual situation.
Copyright 2021 The Business Journal, Youngstown, Ohio.