May The Best Plan Win

Entrepreneur, April, 2001 by Mie-Yun Lee

There's more to retirement planning than a 401(k).

The 401(k) is currently America's most popular retirement plan, and in many ways, it's an excellent benefit plan for employees. But its design is not always hands down the best match for entrepreneurs. Luckily, there are some worthy alternatives.

To begin with, do you really need to offer a retirement plan? Well, while it's true that a retirement plan alone may not attract prospective employees, offering one is essential to creating the most attractive overall compensation package.

"Today, everyone is completely aware that they have to fund their own retirement," says Joann McDermott, vice president and director of retirement plan services at Advest Inc., an investment firm in Boston. Most working Americans expect to do this, she says, through their places of employment. A 1999 nationwide study of 1,076 employees, conducted by Deloitte and Touche to identify the top five benefit priorities for the coming year, showed that 75 percent of those surveyed ranked "evaluating the adequacy of my current level of retirement" savings" as No. 1.

Of course the other compelling reason for implementing a retirement plan is the substantial tax benefits you'll receive. In fact, most financial advisors encourage the setting up of some sort of plan as part of a legitimate tax shelter.

Given these reasons , the 401(k) plan--with its costly setup fees, high annual record-keeping fees and onerous IRS testing requirements-- can eventually stretch business owners' budgets further than necessary.

THE CHOICE IS YOURS

The following are brief overviews of some of some of the best alternatives to the 401(k): SEP, SIMPLE-IRA and Keogh profit-sharing plans:

SEP-IRA (Simplified Employee Pension -Individual Retirement Account): The SEP-IRA is a plan funded wholly by you, the employer. So what's the appeal? There are almost no administrative costs involved in setting it up.

All you need to do is complete Form 5305-SEP (available at an IRS office or from www.irs.gov) and distribute a copy to every eligible employee. You must also give all employees written notification of the amount contributed to their SEPs each year, a requirement easily satisfied by reporting contributions on the employee's W-2 Form.

Because of the high contribution levels (up to 15 percent of each employee's total compensation, with a maximum contribution of $25,500 per year), owners and executives can squirrel away more of their salaries than they can with 401(k) plans. A SEP-IRA is also the best plan if profits aren't steady from year to year because employers are allowed to adjust contribution levels annually--they can even skip contributions in some years if it's absolutely necessary. Keep in mind, though, that employees seeking stability in their plans may become irritated.

What you spend on this plan can still add up if you don't watch your contribution levels. When your employees meet the eligibility requirements of the plan, you must include them and contribute the same percentage to each employee's retirement account.

SIMPLE-IRA (Savings Incentive Match Plan for Employees-Individual Retirement Account): The SIMPLE-IRA is only for companies with 100 employees or fewer. Like the 401(k), it's administered through insurance companies, banks or mutual fund companies, and contributions are placed in mutual funds or variable annuities. Setup fees average $15 to $25 per employee, with annual administrative and recordkeeping fees costing up to $600.

Unlike the 401(k), though, employers must make annual contributions to the plan. That can be done one of two ways: You can match employee contributions dollar for dollar, up to 3 percent of each employee's pay (or $6,500 in 2001, whichever is less), or you can contribute 2 percent of every eligible employee's pay to his or her account, up to $3,400 apiece.

Setup and administration fees are low because, unlike with the 401(k), employers aren't obligated to provide investment options. Also, the plan isn't subject to the costly discrimination testing required by the IRS to ensure that 401(k) plans don't favor highly compensated employees and owners.

With the SIMPLE-IRA plan, however, it's important to note that participating employees are immediately 100 percent vested. Therefore, they retain complete ownership of any contributions you make to their plans, no matter when or why they leave your company. The upside is that your contributions won't exceed $6,500 per employee each year.

Keogh profit sharing: Although you won't save much in administrative costs, you may want to consider this profit-sharing plan. Similar to SEPIRAs, Keogh plans are mainly employer-funded but are much more flexible than SEPs. Also, of the plans mentioned here, the Keogh allows the highest percentage of annual income to be saved toward retirement.

As a result, the Keogh plan is generally attractive to businesses with several highly paid owners and executives. Law firms and medical practices, for example, tend to gravitate toward it. Although anyone can establish a Keogh plan, it is best for companies with 10 employees or fewer because the funding burden is entirely on the employer.