401K for Small Businesses
Saving for retirement is important, but it’s not always easy. As most of us know, there seems always to be something (or someone!) laying claim to our hard-earned dollars. If it’s not expensive auto repairs, then it’s those credit card balances we never seem to get ahead of. And if it’s not that, then it’s health insurance premiums and income taxes. But sometimes, it’s none of the above – it’s simply that we don’t know where to begin. After all – there are quite a number of savings vehicles out there, and it’s not always easy to know which one would be right for us.
One of the more popular ways to save for retirement over the past few years has been the 401(k) plan. Few types of benefit plans have been as well-received by both employers and employees as 401(k) plans have, and few offer as many benefits – from the tax benefits enjoyed by employers, to the retirement benefits enjoyed by employees.
How does a 401(k) plan work? Most 401(k) plans permit employees to contribute a fixed percentage of their before-tax pay, usually between one and 25 percent. Current tax law limits the employee contribution to a maximum of $17,500 in 2013, adjusted periodically for inflation. Participants age 50 and over may make a special “catch-up” deferral of $5,500. When combined with an employer match and discretionary contribution, the total contribution cannot exceed the lesser of 100 percent of income, or $51,000. The result for the employee is reduced taxable income.
The employer determines which investments will be available to employees under the 401(k) plan - options which generally include stocks, bonds, mutual funds, government securities, and money markets. From among these options, employees select the investments that suit their risk tolerance and investment “horizon” – the amount of time over which they will be investing.
Employees should consider several factors when weighing their investment choices: Age, other retirement plans, their current financial situation, investment objective and risk tolerance. The general rule of thumb is that the greater potential return comes with greater potential for risk. Employees should be aware that the investment return and principal value of their account will fluctuate, so that they may have a gain or loss when they redeem their account.
Depending upon the terms of the plan, employees may change their investments or the amount they invest anywhere from once a year to as often as they like. Although most plans also allow individuals to take loans, the 401(k) plan is meant to be a retirement investment. Therefore, surrenders or withdrawals from a 401(k) will generally incur a 10 percent tax penalty if they’re taken prior to age 59 ½ - this in addition to any income taxes that may be due. Withdrawals after age 59 ½ will generally be taxed on the full amount of the withdrawal at ordinary income tax rates.
Why should employees take advantage of a company-sponsored 401(k)? First, employer contributions are essentially “free” money. Second, the 401(k) plan is a tax-deferred way to accumulate money for retirement. Contributions, including dividends and any capital gains can grow on a tax-deferred basis until they are withdrawn. Because of this tax-deferred compounding, plan assets are able to grow more quickly than would be possible in a similar taxable investment.
But perhaps more important, 401(k)s help employees take control of their own retirement. There is a caveat however: employees must realize that retirement planning is a long-term objective. Playing the ups and downs of the stock market will generally work against them. This sort of day-to-day investing should be left to the professionals. Instead, plan a steady investment course and stick to it. No matter how you invest, a key component to a healthy investment strategy is time.
Employers also benefit from providing a 401(k) plan because they can deduct company matching and discretionary contributions to the plan, while the salary deduction portion of a 401(k) also saves on taxes. On the not so advantageous side, administrative costs are not minimal.
Although not particularly complicated, administering a 401(k) plan can be time-intensive. Constant accounting, thorough employee communication and nondiscrimination testing are all a part of the 401(k) equation. Although larger companies often have the ability to administer their own 401(k)s, others rely on third-party administrators. In the latter situation, look for that company that can provide your employees with both an 800-number and internet access, as well as daily valuations, quarterly statements and information stuffers that educate employees about the plan.
Although 401(k) plans are not the end-all when it comes to employee benefits for key personnel, few benefits are able to provide so much for employees. They allow employees to save taxes today, while accumulating assets for tomorrow. And in an ideal world, a satisfied employee makes for a productive employee.
The views and information contained herein have been prepared independently of the presenting Representative. It has been presented for informational purposes only and should not be construed as investment advice.
This information is not intended as tax advice. Please consult with your accountant prior to acting on any information in this correspondence.