Even during times when employers can have their pick of job candidates, hiring and keeping good employees can be difficult when companies compete for top candidates. Offering a good pension plan can go a long way towards enticing potential employees and retaining employees for the long haul. Understanding the types of pension plans available can help small business owners select the one that’s the best fit for their type of business.
Types of Pension Plans
Pension plan types can vary in terms of who’s covered under a plan, contribution limits and administrative requirements. These differences can affect whether a particular plan will work best for a small number of employees versus a large number or for a sole proprietorship.
Basically, there are two types of pension plans: defined benefit plans and defined contribution plans. Defined benefit plans are employer-funded based on an employee’s age, earnings and years with the company.
Defined contribution plans may be funded by both the employer and the employees though employees hold the primary responsibility for funding the plan. Employer portions may be based on a matching contribution amount or a percentage of an employee’s contribution.
As different businesses may have different priorities in mind when starting a pension plan, knowing your business needs, both now and in the future can help in determining which plan will work best. When considering a pension plan it is advisable to seek advice from a financial advisor or accountant such as ArkFinance.
With so many tasks and responsibilities to handle as it is, many small business owners prefer simple, easy to administer pension plans with minimal fee costs. Of course, part of the process in setting up a plan involves adhering to IRS filing requirements. Plans with minimal filing requirements include:
- the Simplified Employer Pension Plan (SEP-IRA), a defined benefit plan and
- the Savings Incentive Match Plan for Employees (SIMPLE IRA), a defined contribution plan.
For sole proprietor businesses, the Self-Employed 401(k) plan does have annual IRS filing requirements but only after plan assets exceed $250,000.
Something else to consider involves plan guarantees in terms of what happens if a business is no longer able to fund its pension plan. Defined benefit plans are backed by the federal Pension Benefit Guaranty Corporation. This means the government will continue to payout benefits to pension recipients when a business can no longer fund the plan. There is no government guarantee available under defined contribution plans.
In the event a plan recipient dies, the listed beneficiary would receive any remaining benefits under the plan.
Employer vs. Employee Contribution Limits
The amount of flexibility allowed for contribution amounts is another factor to consider when deciding on a small business pension plan. In cases where a business’ income fluctuates, the flexibility of a SEP-IRA allows employers to contribute according to their income earnings. This includes contributions made towards the owner’s or employer’s pension as well as the employees’. As of 2012, annual contribution limits for SEP IRAs cannot exceed 25 percent of earnings up to a maximum of $50,000.
With SIMPLE IRAs, employees can contribute up to 100 percent of their earnings, not to exceed $11,500. Employers can match employee contribution amounts up to one to three percent of an employee’s earnings.
The type of pension plan a business selects will determine how taxes are applied for any contributions made to the plan. In general, all plans include a tax-deferred growth provision, meaning no taxes are due until a withdrawal is made. Employers may also deduct any contributions made as a business expense. Employers offering a pension plan for the first time can also receive a tax credit of up to $500 for the first three years for any expenses involved with plan start-up and maintenance. For employee-funded plans, employee contributions are made on a pre-tax basis with a tax-deferred growth provision.