Unlocking Talent: A Guide to Retirement Plans for Business Owners

Greg Farrell, Vice President, Senior Wealth Manager

Hiring is hard. As a business owner, the number one decision you will make is hiring the right people. While salary is always an enticement for candidates, a good future employee will care more about benefits and culture than just the future paycheck. Therefore, as an employer, you should think about retirement plans to provide that extra incentive to a prospective candidate to join your firm. Additionally, once onboard, a good retirement plan is an excellent retention tool, especially if there is some type of vesting option, which makes moving to another firm a bit more difficult knowing dollars will be left on the table.

Unlocked pink door

The challenge for employers is figuring out what is the best plan out there – a plan which can do all of the above yet be financially flexible and not a drain on the business. 

Navigating Government Regulations:

As with all retirement plans sponsored by an employer, government regulations might be your first hurdle to clear.  Most larger retirement plans have guidelines set by the Department of Labor, and specifically fall under the Employee Retirement Income Security Act of 1974 (ERISA).  The government has a vested interest in how company sponsored retirement plans operate, with concern that employees are treated fairly, yet in a reasonable way allowing the employer to manage their business and make choices which are in the best interest of the company. 

The underlying reason the government has an interest in private retirement plans is that these plans provide for an employee’s future.  While the government is also in the retirement business, via social security, social security was never intended to provide all of a person’s retirement income.      

Evolution of Retirement Plans:

Long before the dawn of company sponsored plans such as the 401(k), in the 1950s, 60s, and 70s, the average employee typically worked most of their lifetime for one firm as the goal was to amass years of service towards a higher pension.  When they retired, typically at age 65, they received their pension plus a monthly sum from social security.  This worked until life expectancies started to rise dramatically.  In fact, if a 65-year-old worker retired in 1970, they were lucky to have survived to 65, since when they were born in 1905, their life expectancy was 50 years old.  By making it to 65, their odds greatly increased, with a new life expectancy of 80 years old according to the CDC1.  This longer period in retirement started to stress many firms financially.  As we know today, life expectancies have further increased, adding to the stress on pensions and on the social security system.  Today, all of us can easily name multiple people in their upper 80s, 90s, and even early 100s.  Retirement income is serious business.   

With this aging of the population, companies started to feel the budgetary impact of carrying employees for many years in their retirement, and therefore needed to find new ways to help their employees, while also staying in business.  So, the Revenue Act of 1978 was passed, which established the 401(k).  From then on, employees principally bore the responsibility of their own retirement funding (while being enticed by current tax savings through deferrals and some company matches). 

We provide this historical backdrop to emphasize why the government has a vested interest in many plans. However, there are many plans which do not require government oversight and are good tools for firms to help their employees, some of those employees also being the owners.  

Choosing the Right Plan for Your Business:

So, back to attracting and keeping new employees. What plans make the most sense to an employer? What if business cash flow varies, year to year, do contributions still have to be made when times are tough? The answer is maybe, or maybe not. 

Choosing a retirement plan has a lot to do with the number of employees, as well as if you, the employer, want to contribute to the plan. For small businesses, starting with just a sole proprietor business and up to 20 employees, there are several options; some requiring a contribution from the employer, or just a plan for which the employee can contribute from their earnings. 

The most basic of these types of plans are payroll deduction IRAs, which have no employer mandates and are just an arrangement to allow for payroll deductions to be transferred to an employee’s individual retirement account (IRA).  Even something as simple as accommodating for the transfer to an IRA is a true benefit, which employees value.  Depending on the person’s age, in 2024 they can contribute up to $7,000, and if they are 50 and older, they can contribute up to $8,000.  

If someone is self-employed, they have many options, including setting up a solo-401(k) plan or even establishing a pension plan for themselves. The advantages here typically lie in the ability to set aside a much larger sum from earnings, which can super-fund the retirement plan while also deferring current taxes. Except for the actual pension plan option, most self-employed plans are quite easy to establish and require no or nominal government reporting. 

A Savings Incentive Match PLan for Employees (SIMPLE IRA) can be an option for employers with fewer than 100 employees.  The plan is intended to be simplified, so there is not too much work to be done by the employer, and there is no direct oversight by ERISA, but there are contribution requirements for the employer.

In a SIMPLE IRA plan, the employer sets up the mechanics of an IRA for the employee, which the employee manages on their own.  The mechanics basically involve linking an investment firm so contributions can be made to the plan.  SIMPLE IRAs do have a much higher level of employee contributions allowed versus a traditional IRA, so this is an advantageous benefit for retirement planning.  In 2024, an employee under age 50 can contribute up to $16,000, and for those 50 and older, the maximum contribution level is $19,500. 

Again, the employer must contribute, and there are options to be elected by the employer. The employer needs to decide if they want to contribute 2% as a non-elective contribution, which means every eligible employee gets 2% of their salary, regardless of whether the employee contributes or not. Alternatively, the employer can elect a Safe Harbor 3% contribution to those who participate in the plan. This 3% is a dollar-for-dollar match, so if the employee contributes less than 3% of their pay, the employer only needs to match the contribution.  Contributions can be adjusted down to 1% during a harder year, but there are rules around how many times this can happen. Regardless of which contribution level the employer chooses, the contribution is 100% vested to the employee, so if they leave the next day, they take the match.  

New in 2024, if you are an employer who has not provided any retirement plans in the past 3 years, you might be able offer employees a higher contribution level (at 110%), but if the firm has more than 25 employees, the employer would have to raise their level of contribution, too. 

The bottom line is a SIMPLE plan is an easy plan, with no annual reporting needed, and it checks a couple of boxes as the employee gets a decent plan with contributions.   

For the semi-generous employer, with fewer than 20 employees, there is the Simplified Employee Pension plan (SEP). This allows for contribution flexibility, whereas if you have a tough year, you do not need to contribute.  SEPs are employer contribution plans only, so employees do not contribute.  SEP plans are always 100% vested to the employee, which might not help with retention, but given a generous employer contribution, that could aid in keeping employees.  SEP plans usually are good family business vehicles.   

New Trends and Considerations:

In 2024, SEPs can have up to a maximum of $69,000 contributed per employee, or 25% of pay, whichever is smaller. These plans make them a nice vehicle for super-funding and current tax deferral, while also allowing for annual cash flow variance. The disadvantage to these plans is that every employee needs to be treated equally, so if you fund at 25%, all employees get 25% of their pay contributed by the employer.  An advantage is these plans are also easy to establish and require no government reporting.

A plan which can be used for small and large firms is a profit-sharing plan.  Like the SEP plan, this type of plan is an employer-only contribution plan, which makes it a nice benefit to employees. There are rules and regulations which need to be followed, but unlike a SEP, there can be vesting periods to encourage employees to stay. Annual filing is required. 

As mentioned earlier, via the Revenue Act of 1978 there are 401(k)s, which are the usual retirement plans for most firms. These plans are formally known as defined contribution plans (or DC plans) and come in many shapes and sizes; some which require employer contributions, some in which the employer makes an elective contribution (or match), and some in which there is no employer contribution. They all allow employees to defer a fair amount of their compensation, which helps with retirement funding and planning. In 2024, the maximum employee deferral is $23,000 for employees under age 50, and for those age 50 and over, the maximum employee deferral is $30,500.  

There is a fiduciary requirement of the plan sponsor (typically the employer) to provide education and selection of funds. Most of this burden is usually provided to the employer by the custodian of the plan. These types of plans have annual reporting requirements which a third-party administrator (TPA) can help with, and the custodian might also act as a TPA to ease the complexity of the plan. 

Finally, defined benefit contribution plans (DB plans or pension plans) are another option. If a pension exists, this can help keep employees for a longer period. Defined benefit plans have considerable rules and regulations, which do not make them a favorite of employers in establishing or maintaining.  These plans are a great benefit, but the establishing firm needs to do their due diligence to determine if this is the right fit. 

Given the government’s interest in retirement planning, there are new laws effective in 2024 in which student loan payments can be used towards retirement contributions.  The burden of large student loans has led to the inability of some employees to contribute to retirement plans due to the lack of available funds; so, starting in 2024, if an employer offers a match, student loan payments can help in the equation.  So, while someone might not contribute anything to their 401(k) (or 403(b) which is used in the not-for-profit sector), or a SIMPLE IRA, the employer can count those qualified payments just as they would if the employee contributed to the plan.  We will not go into the rules, but when trying to attract an employee, this might be a talking point which a competing employer might not be mentioning. 

In Conclusion:

As you can see, there are many options available to employers to attract and retain their valued employees.  Deciding on which plan is not easy, as every business is different, but having a plan usually is a true value to any employee. As an employer trying to decide, make sure you talk with numerous professionals, starting with a financial advisory firm such as Howe & Rusling, an accountant, and an attorney depending on the complexity of the plan. 

Citation:

  1. CDC – Life Expectancy at Birth, by Race and Sex, 1900-2010:

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Greg Farrell

Greg, Vice President and Wealth Manager, helps clients with the guiding principle of ‘plan, position, and preserve’.

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