With a tightening job market, a 401(k) and its iterations can help give business owners a leg up.
In a candidate-driven job market, competitive retirement plans continue to be in high demand. You may know quite a bit about 401(k) profit-sharing plans specifically, but their iterations – the solopreneur or one-person plan, the safe harbor plan and the SIMPLE plan – could give your business a leg up as well. Let’s dig in.
The 401(k) plan
The 401(k) is the bedrock of retirement planning. Simply put, this is a profit-sharing retirement plan that allows employees to make elective salary deferrals and avoid present-day taxes on that portion of their income. Most employers, including not-for-profit organizations, can offer a 401(k) plan to their employees. The exception here is any government entity.
In addition, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) allowed employees to add qualified Roth contributions to their 401(k) plans; however, the Roth 401(k) contributions only apply to employees’ elective salary deferrals. And since it is a Roth vehicle, the contributions are after-tax, not pre-tax like the typical 401(k).
- Pre- and post-tax contribution options for the opportunity to put more into their retirement savings.
- Automatic payroll deduction supercharges retirement savings.
- Saver’s credits are available for low and moderate income workers that can help offset part of the first $2,000 they contribute.
- Not required to make contributions to employee accounts.
- May be eligible for a $500 annual business tax credit in the first three years of the plan.
The solopreneur or one-person 401(k) planThis retirement savings plan can work well for individuals who are sole operators of their businesses. It can also work for those who share ownership and responsibility with family members or with partners, with the caveat being that those individuals must each own at least 5% of the business. The owners-only 401(k) is available to business entities including sole proprietorships and partnerships, as well as C, S and limited liability corporations.
- Can contribute very high amounts of income from either profit or compensation – totaling up to $58,000 in 2021 plus a catch-up contribution of $6,500 if you are 50 or over.
- Ability to choose your tax benefit: deferred or immediate.
- Your spouse can be included if they receive income from your business, effectively doubling your contribution.
Safe harbor 401(k) planA safe harbor 401(k) plan is similar to a traditional 401(k). But it has one key benefit: low employee participation doesn’t keep the business owner from achieving the maximum pre-tax payroll deferral limit. But do note that the company must be willing to make contributions on behalf of its employees.
- If you own your business, you don’t have to worry about your contributions being capped by ADP testing if you are highly compensated.
- For a small company having to make mandatory contributions, implementing this plan could be less expensive than nondiscrimination testing.
- Less expensive to set up than traditional plans.
- Same benefits as a traditional 401(k), plus contributions are vested immediately.
A Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) PlanA SIMPLE plan provides for elective salary reduction contributions (deferrals) by eligible employees up to $13,500 for 2021 (or 100% of compensation, whichever is less). The plan also requires a mandatory contribution by the employer that is either a dollar-for-dollar match of up to 3% of compensation (can go as low as 1% in two out of five rolling calendar years) or a nonelective amount of 2% to eligible employees, whether an employee participates in the plan or not. The employer cannot make any additional contributions and may not sponsor any other retirement plan in conjunction with a SIMPLE plan.
For what may be considered a tradeoff to this mandatory contribution, the good news is that there are minimal tax filing requirements, no nondiscrimination tests and no top-heavy contributions required by the employer. These provisions allow any employee, including a highly compensated one, to defer up to $13,500 (2021) without any consideration to any deferrals made by other employees.
Catch-up contributions are allowed in SIMPLE plans for qualified individuals. The contribution is in addition to the regular salary reduction contribution and the match or nonelective contribution. This additional contribution is $3,000 for 2021 and will be indexed for inflation thereafter.
- You can offer a SIMPLE IRA or 401(k).
- There is no annual filing of Form 5500 and so none of the associated costs of staff time, administrative burden or payroll technology required to do so.
- Pre-tax contributions are 100% deductible for the business.
How to choose?
Choosing a plan requires a careful look at your current plan if you have one, your employee demographics, overall company goals –growth, retaining talent or otherwise – and at how each plan aligns with those.
Your advisor can help guide you through the pros and cons of each and connect you with specialized fiduciaries who can oversee any administrative and legal responsibilities involved.
- Evaluate current plans for you and your employees – are these competitive with the market?
- Identify areas where potential tax benefits could help grow your business.
- Reach out to your advisor to make sense of the options available.
Sources: humaninterest.com; employeefiduciary.com; nerdwallet.com; money.usnews.com
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Investors should consider their personal investment horizon and income tax brackets, both current and anticipated, when making an investment decision, as these may further impact the results of the comparisons. Keep in mind that results will vary as investing involves risk, fluctuating returns and the possibility of loss.
Disclosures: Atlantic Union Bank Wealth Management is a division of Atlantic Union Bank that offers asset management, private banking, and trust and estate services. Securities are not insured by the FDIC or any other government agency, are not deposits or obligations of Atlantic Union Bank, are not guaranteed by Atlantic Union Bank or any of its affiliates, and are subject to risks, including the possible loss of principal. Deposit products are provided by Atlantic Union Bank, Member FDIC.
We continue to recommend, if you have not yet done so, that you consult with your tax advisor regarding any questions you may have about your retirement plan.