5 Things Every Small Business Owner Needs to Know About Employee Retirement Accounts

Among small businesses, employer sponsored 401(k) plans seem to have gotten a bad rap. According to the United States Government Accountability Office, between 51 and 71 percent of small business employees don't have access to a workplace retirement savings plan.

There is a misconception that retirement plans are just for huge companies. However, this isn't true, and offering a retirement savings plan is the biggest step that a small business can take to increase workers' retirement savings. Let's review some of the many reasons why offering an employer-sponsored retirement account is a great idea for small businesses of all types. (See also: 8 Common Myths About Starting a Small Business)

1. Employees may prefer a retirement plan over a salary increase

According to a 2015 Glassdoor survey, 31 percent of workers valued a workplace retirement account, such as a 401(k) or pension plan, over an increase in pay. This makes sense; several studies have shown that workers benefit from automatic paycheck deductions to contribute to a workplace retirement plan. The Employment Benefit Research Institute found that two-thirds of employed workers not currently saving for retirement say they would be likely to start if automatic paycheck deductions ranging from 3 to 6 percent were used by their employer. By offering a retirement plan, small businesses may be able to attract more talent.

2. There are low-cost options available

Many small-business owners have the misconception that their only option to set up a workplace retirement plan for their employees is to pay an annual 1.5 to 2 percent fee to a provider. But nowadays, business owners have access to many lower cost options. Here are three examples of 401(k) providers for small businesses and their schedule of fees for employers:

  • Captain 401: $499 setup fee; monthly cost starting at $120 plus $4 per employee.

  • Employee Fiduciary: $500 setup fee for new plans; $1,500 annual fee plus a custody fee of 0.08 percent of plan assets.

  • Ubiquity: $495 setup fee; monthly cost starting at $115 plus other transaction service charges.

Besides providing lower costs, choosing a third-party plan provider allows you to delegate certain plan responsibilities, such as implementing nondiscrimination testing for retirement plans (in layman's terms, making sure that a company isn't favoring specific employees when making contributions). This lets you focus more on core activities of your business.

3. Eligible small businesses can claim tax credits

Those fees to set up and run a retirement plan may be tax deductible. If your small business employed 100 or fewer individuals who were compensated at least $5,000 in the preceding year, and your business hasn't offered a workplace retirement plan in the past three years, it may be eligible for the Credit for Small Employer Pension Plan Startup Costs.

Using Form 881, eligible small-business owners can claim a credit of up to $500 for qualified setup and administration fees, and costs to educate employees about the plan for each of the first three years of the plan. You can start claiming the credit in the tax year before the tax year in which the plan becomes effective, and you may carry it back or forward to other tax years if you can't use it in the current year.

Just remember that whatever plan expenses you use toward this credit, you can't use as business expense deductions.

4. Employer contributions are tax-deductible

In 2017, the Employee Benefit Research Institute found that nearly 73 percent of workers not currently saving for retirement would be at least somewhat likely to start if contributions were matched by their employer. The good news for employers is that the IRS usually allows them to deduct these matches, subject to contribution limits on qualified employee plans (including the employer's own plan).

  • Defined contribution plan: An employer can deduct contributions to an employee retirement plan, up to 25 percent of the employee's annual salary. In 2017, no more than $270,000 of an employee's annual salary could be used when calculating that 25 percent.

  • Defined benefit plans: The IRS recommends hiring an actuary to figure out your deduction limit based on the rules of your defined benefit plan.

Remember that all deferred employer contributions, including earnings and gains, are tax-free for employees until distributed by the small-business plan. This is why an employer contribution is so valuable.

Let's assume that an employee and your small business have a 20 percent and a 10 percent tax rate, respectively. If you were to give that employee a $4,000 raise, he would only actually see $3,200 of that and your small business would pay $400 in taxes. On the other hand, with a $4,000 employer contribution to the employee's plan, the employee gets the full $4,000 now and the employer gets to deduct the $4,000 as a business expense.

5. Some states provide their own retirement plans

Across the nation, many states have launched, or are preparing to launch, state-sponsored plans to help workers save for retirement. Here are a few examples:

  • California: The California Secure Choice program (scheduled for soft launch in late 2018) will offer a retirement savings option to millions of workers employed by small businesses (under 100 employees) who don't have access to a retirement plan.

  • Connecticut: Nearly 600,000 workers lack access to a workplace retirement plan in the state of Connecticut. The Connecticut Retirement Security Program (currently in planning stages) will aim to offer retirement plans to private sector workers without a retirement option through their employer.

  • Oregon: OregonSaves launched in November 2017 and aims to offer workers employed by small businesses of less than 100 people a retirement savings plan. The program is expanding in "waves," with the next wave planned for spring 2018.

Depending on the state that your small business operates in, you may have to address whether or not your small business will offer a workplace retirement plan soon.

For example, let's say you have a small business in Oregon. OregonSaves is planning its next registration "wave" for spring 2018 for small businesses with 50 to 99 employees. If your business is not offering a retirement plan, you'll have to start enrolling employees in the state program (unless the employees opt out) on May 15, 2018. Following suit, small businesses that employ 20 to 49 workers will have to enroll on December 15, 2018.

The bottom line: Take action today

As a small-business owner, it makes sense to take a look at offering a retirement savings plan to your employees. This is a perk that employees value, is available through lower cost options, and provides tax breaks to both employees and employers.

In the near future, your employees may have to enroll in a state-sponsored retirement plan depending on whether or not you offer a workplace retirement plan. Offering an employer-sponsored retirement plan is an effective way to attract and retain the best talent and demonstrate that you have your employees' best interest in mind.

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5 Things Every Small Business Owner Needs to Know About Employee Retirement Accounts

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