Retirement plans meet employee, business needs

If you’re a small-business owner, you’ve invested a lot of time, effort and money into building your company. While owning a business can be rewarding, it does present a variety of unique financial and investment challenges, such as protecting your assets and reducing tax liability. To address these and other issues, you may want to consider an employer-sponsored retirement plan, which can offer significant advantages and tax benefits to you and your employees.

A retirement plan not only gives your business the competitive edge in attracting and retaining quality employees, it also offers the ability to accumulate retirement funds tax-deferred – which means you don’t have to pay taxes on the money until you withdraw the funds. Keep in mind, taxes will be due at withdrawal, and any withdrawals before age 59 1/2 may be subject to a 10 percent penalty by the Internal Revenue Service.

Employer retirement plans are categorized as either salary deferral plans or employer-funded plans. Salary deferral plans let participants contribute a portion of their paychecks directly into the retirement plan. Depending on the type of plan, an employer also can make additional contributions.

Employer-funded plans are just that – the contributions to the plan come directly from the business, and employees don’t make their own contributions.

There are several salary-deferral plan options:

• Simple individual retirement accounts allow employees to make pretax salary deferrals into the plan. In addition, the employer makes a required contribution, providing a tax deduction for the business. This plan is suitable for sole proprietorships, partnerships and corporations with less than 100 employees who each have earned at least $5,000 in compensation for the prior year. Nonprofit organizations, including government entities, may also have simple IRAs.

• Owner-only 401(k) plans are retirement plans for businesses with no employees other than the owners and their spouses. This includes self-employed individuals, corporations and partnerships that want to enhance their pre-retirement contributions. This plan allows the participant to make tax-deductible salary deferral contributions in addition to an employer tax-deductible contribution. All earnings accumulate tax-deferred.

In addition to salary-deferral plans, there are several types of employer-funded plans that business owners might consider.

• SEP – or simplified employee pension – plans are available to business owners and are a collection of individual retirement accounts. This is a cost-effective plan that provides tax deductions for the business and requires no annual Internal Revenue Service filings. These plans are suitable for any type of business, including sole proprietorships, partnerships and corporations. With an SEP, only the company contributes to the plan, not the employee.

• Profit-sharing plans are defined contribution plans. This means that the amount contributed to the plan is limited, but the amount paid to the employee at retirement is discretionary. The amount paid to the employee at retirement will depend on plan contributions and on the return earned by the investments in the plan. Contrary to what the name may imply, contributions to a profit-sharing plan are not necessarily based on the profitability of the company, but on the amount of each participant’s compensation and how much the employer chooses to contribute to the plan. Profit-sharing plans allow the employer to make tax-deductible contributions – the employee does not contribute to this type of plan. Any type of business, including sole proprietorships and partnerships can set up this plan.

There are several options available to business owners. A financial consultant can help owners to select the most appropriate plan for their goals and their employees’ needs. Companies that already have retirement plans in place should review them to ensure that it meets those needs.

Timothy M. Reese is senior vice president, investments, with A. G. Edwards & Sons Inc., member SIPC.