Retirement plans
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Retirement plans for businesses

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During March and April, you are inundated with compliance work. When you wrap up business returns, and look at W2s and financials, it may be worthwhile to note whether your clients have retirement plans set up in their businesses. Having quick conversations with clients to gauge their interest in setting up a tax-favored retirement plan after busy season for them and their employees could help you move from a compliance-only relationship to an advisory relationship.

There are a couple of factors to weigh when thinking  about retirement plans. This article is geared toward explaining some key different types of retirement plan options.

Defined benefit pension plan

A defined benefit plan provides for a fixed benefit at retirement. The factors involved in that calculation are generally based upon years of service and compensation according to a selected formula. Most defined benefit plans generally pay benefits in a form of an annuity, over the life of the participant, or joint lives of the participant and spouse. But other plans could include payment of benefits in a lump sum. A “cash balance plan” is an example of a plan where the payment is expressed as a cash lump sum.

The upside of using a defined benefit pension plan is that they often create the greatest current deduction from income and the greatest retirement benefit. However, the administrative costs associated with running these types of plans can get rather expensive, since actuarial costs are involved. Because of the large fees involved to keep up with the program, some taxpayers will opt for the defined contribution plan instead.

Defined contribution plans

A defined contribution plan provides an individual account for each participant with benefits based solely on the amount contributed to the participant’s account. A 401(k) is a type of defined contribution plan. An employee can elect to have a certain amount of pay deferred and contributed by the employer to the plan. Employee contributions could be done pre-tax or after­ tax [Roth 401(k)]. An employer could provide matching contributions subject to a vesting schedule, but it would have to be laid out in the plan documents.

401(k) plans are subject to annual IRS-mandated nondiscrimination testing requirements to confirm highly compensated employees do not disproportionately benefit and no IRS contribution limits are exceeded. Highly compensated employees are employees who earned more than $135,000 in the preceding year. Typically a third-party administrator will handle these requests. But there are safe harbors companies can qualify for that would avoid having to go through testing.

SEP and SIMPLE plans

Small businesses could adopt a Simplified Employee Pension (SEP) and receive similar tax advantages to qualified plans by making SEP-IRA contributions on behalf of employees. SEPs are an alternative to “qualified” retirement plans. Since the SEP is not a qualified plan and not subject to strict plan documents, the employer can decide whether to make annual contributions. In addition, the ease of administration makes the SEP popular for small businesses. Once a SEP is set up, the employer will get a current income tax deduction for contributions made on behalf of the employee. The employee’s account will grow tax free until distributions are made, typically at retirement. But the limits to contributing to the SEP is based on the lesser of 25% of compensation and $61,000 for 2022. Two of the requirements are that all regular employees must elect to participate in the program and contributions cannot discriminate in favor of the highly compensated employees.

Businesses with fewer than 100 employees could establish a Savings Incentive Match Plan for Employees (SIMPLE). Under a SIMPLE plan, the IRA is established for each employee, similar to a defined contribution plan. The employer would make matching contributions based on contributions elected by participating employees under the employee’s salary reduction arrangement.

Be your clients’ advisor

There are many options out there for retirement planning. Creating a bespoke retirement plan solution along with a competent investment advisor will allow you more opportunities to be a trusted advisor with your client.

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