Want to minimize your company’s federal income tax bill? Most business owners do, and a pension plan is one to help achieve this goal. Most employer-sponsored pension plans offer a sizable tax deduction for employer contributions to a qualifying pension plan. Even a self-employed business owner without employees can benefit from establishing a retirement plan. Below, you will find an overview of pension plan advantages and options.
Advantages of Sponsoring a Retirement Plan
Beyond the federal income tax deduction, there are several other reasons to consider sponsoring a retirement savings plan:
- The growth in the retirement savings fund is tax-deferred.
- There are several qualifying plans available.
- Tax credits are available for starting a plan.
- Companies can provide their employees the opportunity to save in a tax-favored plan.
- Plans provide guaranteed retirement income for participants.
According to the IRS, less than half of working Americans participate in an employer-sponsored retirement plan. Yet most will need 80 to 90 percent of their salary in retirement. Lower income employees may actually need more than that. Offering employees a tax-favored retirement plan could make a meaningful difference to their lives in retirement.
Two Categories of Retirement Plans
Retirement Plans Come in Two Flavors:
- Defined Contribution (DC) plansDefined Benefit (DB) plans
- Defined Benefit (DB) plans
A Defined Contribution plan bases the retirement benefit on contributions and investment growth. Contributions are usually a percentage of salary or income. The plan type (covered below) dictates the allowed contribution level and who may participate. DC plans are typically easier to set up, administer, and maintain than Defined Benefit plans.
A Defined Benefit plan offers a monthly benefit at retirement age (between 62 or 65) that is a specific dollar amount or based on a formula that considers salary and years employed. The employer is the primary contributor. DB plans have strict rules and penalties related to the maximum benefit. Defined Benefit plans allow for the greatest amount of employer contribution, which in turn offers the greatest tax deduction, but can be inflexible about varying the amount of employer contribution from year to year.
Considerations When Choosing a Retirement Plan
Within these two broad categories of retirement plans, different types of plans (SEP, 401(k), 403(b), 457(b), Payroll Deduction IRA) are available. There are variables within these plans that make some more suitable than others depending on your unique business situation.
Below are several questions you should ask as you work with your accountant and financial advisor to determine the best retirement plan approach for your company:
Questions to Ask About Plan Set-Up:
- What type of business entity is eligible for the plan?
- How many eligible employees are required?
- What is involved with the set-up, maintenance, and administration of the plan?
- Are there requirements for employees covered?
- Is a Roth IRA allowed?
Questions to Ask About Contributions and Distributions:
- Are salary deferrals allowed?
- Is an employer contribution required?
- Are employees allowed to contribute?
- Does the plan offer a catch-up provision?
- Are employer or employee contributions limited to specific amounts?
- Are withdrawals and loans allowed?
- Does the plan allow rollovers?
- Does the plan accept rollovers?
- Are contributions immediately vested or subject to a vesting schedule?
The benefits of offering a retirement plan are substantial to both the employer and its employees. Seek guidance from a professional experienced in using pension plans to reduce taxable income before deciding which type of plan is best for your company.
Many businesses have benefited from these strategies. It’s worth your time to learn more.