How to pick the best retirement plan for your company
As a business owner, you make sure your employees have a competitive salary, a good benefits package and flexibility when it comes to time off, but what about a retirement plan?
With the many challenges business owners face – from monitoring cash flow and managing debt to complying with tax laws, and handling day-to-day demands, putting together a retirement plan can be daunting, but necessary.
Much like salary, benefits and time off, a retirement plan is an effective recruitment and retention tool. In some plans, where companies make generous matching or profit-sharing contributions to motivate employees to take heed and invest in their futures, a retirement plan is a win-win for employees and management.
Employers not only help their employees build a nest egg, but they gain tax advantages now and in the future. And while helping reduce an employee’s income taxes, a retirement plan can also manage risk, create guarantees and offer greater peace of mind to them, whereas at the same time enhancing the company’s value and overall cost effectiveness.
But knowing how to provide the best option begins with understanding the dizzying array of plans. There are essentially two types:
Defined-contribution plans provide that each year, a company sets aside money for employees, but restricts when and how they can withdraw funds. While these types of plans are largely taxed later, withdrawals are taxable.
Structured to allow the investment to grow larger over time, these plans give employers the chance to participate in helping employees plan for their futures by assisting with retirement savings. Matching, automatic enrollment and contributions require minimal effort from employees. And although funds are locked in for a predetermined amount of time, flexibility exists in terms of hardship withdrawals and the ability to borrow money from the account.
Defined-contribution plans include:
• 401Ks, available to employees of businesses
• 403(b)s, available to employees of nonprofits
• 457 plans, available to certain nonprofits, and state and municipal government employees
• TSPs (Thrift Savings Plan), available to federal government employees
Defined-benefit plans are another option. More commonly known as pensions, these plans are ‘defined’ because of the investment structure. Benefits are determined using variables, including salary and length of employment, that define the exact contribution and benefit. Typically, employers make investment and management decisions and assume all of the risk. If a plan doesn’t perform as expected, employers supplement the difference with company earnings.
A defined-benefit plan guarantees the employee a specific payout amount. Much like the defined-contribution plan, the funds are tax deferred, but can either be collected as monthly annuity payments that provide a fixed amount each month until death; joint annuity, which provides that sum to a surviving spouse to their death; or a lump sum upon retirement. The choice of disbursement can greatly affect the amount received.
Since plan options vary so greatly and can significantly impact an employee’s future quality of life, it’s best to explore the different options with a credentialed, independent financial planning team that’s licensed to provide a broad array of solutions. In addition to explaining how each scenario would affect employees and influencing internal/external factors, such as plan participation levels and potential tax code changes, a planner can help a company manage their fiduciary responsibility towards plan participants.
Lennard van der Feltz is a Certified Financial Planner and founding partner of Tempe-based Pinnacle Financial Advisors.