The new tax reform, aimed at lowering the federal deficit, will have a disproportionately large impact on small business owners if it goes through. Until now, tax incentives have rewarded small business owners who contribute to employee retirement plans by making these contributions tax deductible for the businesses. The new reform, which could be announced as early as this December, would lower, or do away with employer incentives entirely. Such a change could make it impossible for many small businesses to contribute to their workers’ benefits, impacting what types of employees they’re able to attract.
For employees, the reform would likely lower the cap on personal contributions to retirement plans, as well as remove their tax-deductible status. Instead of tax-deductible contributions, employees would receive a flat tax credit of 18% or 30% when they withdrew funds in retirement.
All of this spells trouble for small businesses, which often need to offer retirement benefits in order to retain quality employees. And it’s no good for employees, who are statistically less likely to contribute to their own retirement savings if they don’t receive incentive through matching employer contributions.
As a small business owner, whether you provide retirement benefits for employees, or not, will depend largely on what you can afford. Fortunately, there’s a range of options out there when it comes to retirement plans. Setting aside unpleasant future scenarios, let’s take a look at the most common choices small business owners have for offering retirement plans to employees.
SEP IRAs
Simplified Employee Pensions, also known as SEP IRAs, offer a flexible way for employers to contribute to employee retirement funds. Employees don’t contribute to these plans, which are funded solely by the employer. Contributions are capped at $49,000 per year, per employee (as of 2011). In any given year you can choose how much to contribute, ranging from 0% to 25% of an employee’s income. This is great for small businesses because you can hold off on contributing when times are lean and make up for it when your finances improve. Additionally, employer contributions are tax-deductible (at least for now).
For employees, these plans offer no possibility of loan, or “Roth options,” and there is no catch-up for employees who are over 50.
SIMPLE IRAs
This is also known as a Savings Incentive Match Plan for Employees. Both employers and employees contribute to these plans, and employers must match their employees’ contributions each year up to 3% of each employee’s wages. Employee contributions are capped at $11,500 per year (as of 2011). SIMPLE IRAs have a lower employer contribution cap than 401(k) plans (we’ll get to those next), making them more affordable for small businesses.
Similar to the SEP IRA, these plans don’t give employees the option of taking out a loan from their retirement savings, and there is no Roth option.
401(k) plans
These plans are like rewards credit cards: more versatile, with the highest contribution limits and options for employees to borrow funds from themselves in cases of emergency. Employers can set limits on employee eligibility, giving you flexibility to reward longtime employees with benefit packages.Both employer and employee contribute to the plan, with employee contributions capped at $16,500 (as of 2011). Employees may choose to make tax-deferred contributions throughout their careers, only paying Uncle Sam when they withdraw funds in retirement, or they may choose a Roth 401(k) in which all contributions are taxed up-front.
401(k) plans are generally more complicated to manage for employers and more expensive for the company, making them less appealing to some small business owners. Employers must meet Employee Retirement Income Security Act (ERISA) standards and regulations, as well as IRS reporting requirements.
About the author: Tim Chen is the CEO of NerdWallet, an unbiased resource for business and personal credit cards.