Retirement plans are a great way for you and your employees to save on your taxes and for the future. Whether you're looking to set up an Individual Retirement Account (IRA) which is a versatile savings vehicle available only to small businesses with 100 or fewer employees or the more rigid 401(k), it's imperative you know how each works and what options you have.
So before you go rushing to set one up, there are some things you should know.
There are five primary retirement plans defined by the IRS. They are: :
What plan works best for you depends on a couple of different factors. We'll define each of these options as well as their advantages and disadvantages so you can make the right decision for you and your business.
With a retirement plan, employees or individuals can contribute part of their earnings into a savings account that they typically can't access until they retire or hit a certain age.
Depending on the plan you choose, these contributions can be taken directly from someone's paycheck and matched by the employer. The money is then pooled into investments to generate interest.
Unlike the capital gains you would make on your personal investments (like a portfolio of stocks), you either don't pay taxes on the interest generated or pay when you withdraw. This allows contributions of all sizes to grow for your financial future.
There here are four key differences between plans:
For the self-employed, this means some plans will not be available to you unless you're running payroll. Otherwise, choosing a retirement plan is a matter of preference between the features and limitations of each.
Generally speaking, 401(k) plans are the most common retirement plans among employers. Contributions are taken directly from the employee's paychecks and pooled in an investment account to accumulate interest. Employers can also make contributions and enjoy some of their own tax savings, but it's not required.
There are two different types of 401(k) plans businesses can offer:
Employers aren't limited to offering one type of 401(k). Typically, businesses offer both, giving the employee the option of making contributions to a traditional 401(k), Roth 401(k), or a combination of the two. With both types of 401(k) plans, the employee selects from a number of investment options, mainly mutual funds.
401(k)s have one of the most complicated setup processes. You must create a plan document in line with the IRS Code and set up a trust with at least one trustee who oversees the plans contributions, investments, and distributions. Setup costs can range from $500 to $3,000 depending on the service provider.
Since retirement plans can be complicated, the SIMPLE IRA might be tempting on name alone. But SIMPLE is actually an acronym for "Savings Incentive Match Plan for Employees"—no surprise they shortened it.
SIMPLE IRAs are only available to small businesses with 100 or fewer employees. If you fall into this category, you get to enjoy one of the more versatile retirement plans. While 401(k)s are rigid with regards to what kind of investments you offer and how it's run, SIMPLE IRAs have less bureaucracy and more investment opportunities.
A SIMPLE IRA can be set up by filling out Form 5304-SIMPLE or Form 5305-SIMPLE and filing it with the IRS. Alternatively, retirement providers like Fidelity can help you set up and manage the plan.
The SEP in SEP IRA stands for "simplified employee pension." By design, it's one of the easiest options for an employer or self-employed individual to get started on. There are less start-up and operating costs than the common 401(k) plans, plus the eligibility requirements are fairly lenient (minimum age of 21 with at least three years of being in the workforce).
Unique to the SEP is the ability to use it in addition to another retirement plan. For the self-employed, this means you pair an SEP IRA with another IRA plan to maximize contributions and savings.
An SEP IRA can be set up by filing Form 5305-SEP with the IRS. Alternatively, you can work with a retirement plan provider like Charles Schwab to get help setting up and managing the plan.
A Roth IRA offers individuals the opportunity to open up their own retirement account they can contribute after-tax dollars to. When you withdraw money from the account in the future, you won't have to pay income taxes on that money. Your funds generate interest tax-free instead of the tax you would pay on capital gains.
Roth IRAs have the widest selection of investment options. You set your money aside in a bundle of investments including stocks, bonds, mutual funds, exchange traded funds, certificates of deposit, and money market funds. Even non-traditional investments like cryptocurrency are an allowable investment option via "Bitcoin IRAs."
Roth IRAs are widely available and are likely offered by your bank. If you qualify, you can opt for a do-it-yourself approach where you work through an online broker and manage your own investments. Or, if you prefer someone else to handle management for you, look into whether your bank offers Roth IRAs or explore some of the top IRA providers.
With a traditional IRA, individuals make contributions using pre-tax dollars and pay taxes on distributions down the line. As of 2019, it became more widely available because of the SECURE Act, allowing account holders to be any age as long as they have earned taxable compensation.
Similar to Roth IRAs, you can choose between managing your own funds or having an advisor manage it for you. You can work with an online broker or your bank to set up a brokerage account and choose whether you want to work with an advisor. Check out the top IRA providers for the options available to you.
Regardless of which retirement plan you select, you're taking a step towards saving for the future and potentially enjoying some tax savings in the process. Since there's no "˜best' retirement plan, chat with your employees or spend some time figuring out what perks suit your needs most.
To maximize the benefit of your retirement plan, working with a bookkeeper will guarantee that you're capturing every tax benefit to minimize your bill.
At Accracy, we're experienced working with a wide range of payroll providers to guarantee every expense is recorded properly. Come tax time, we'll provide a year-end tax package containing all the info on your retirement plan contributions and other tax deductible expenses to make filing a breeze.
We are offering free 1 Month Basic Bookkeeping to all new customers so you can experience Accracy's seemless and professional services.
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