Adding a Retirement Plan to Your Business: Which One Is Right For You?
Navigating Retirement Plans Can Be Confusing
If you're a business owner wanting to maximize tax savings, adding a retirement plan could save you thousands per year. Sara Johnson, QKA®, AIF®, CPFA®, is on the show to talk about when, how, and what type of plan aligns with your goals.
This might be the best time to start a plan! Numerous tax credits are available to start your retirement plan in 2024/25– someting that has never been offered before.
Throughout our discussion, we weigh the pros and cons of each plan, assisting you in identifying which plan to choose.
Time Stamps
00:00 Introduction to Retirement Plans for Businesses
00:51 Expert Insights: Sarah Johnson's Take on Pension Plans
01:56 Deciding When to Implement a Retirement Plan
06:26 Exploring Simple IRAs and SEPs
12:43 Diving Deeper into 401k Plans and Profit Sharing
23:47 Maximizing Your 401k Contributions: Timing and Strategy
25:14 Understanding Safe Harbor 401k Plans and Deadlines
26:03 The Complexities of 401k Conversions and Setup
28:00 Federal Tax Credits and State Mandates for Retirement Plans
29:36 Choosing Between 401k, SEP, and SIMPLE Plans
32:10 The Importance of Financial Advisors in Retirement Planning
37:06 Exploring Cash Balance and Defined Benefit Plans
43:00 Navigating Retirement Plan Options and Seeking Professional Advice
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Introduction to Financial Planning for Business Owners
Welcome to me financial the podcast designed to inspire your financial life. Hello everyone. And welcome to the podcast. I am Michelle Moses, your host. And today we are going to be talking about retirement plans for your business. Which one is the right one for you? And when would you want to implement one?
Uh, when you own a business, you may want to save more for retirement and offer this benefit to your employees. And it's all free. It's often difficult to decide which plan would be best. There's tax savings, but also the cost to put the plan in place and the time and cost to maintain it. And to further add to this, you don't want to put the wrong plan in place because they're very, very hard to undo.
Uh, and you know, as I, what I just mentioned, the time and the money.
Expert Insights on Retirement Plans
And so today I have Sarah Johnson from ABC Trust to talk to us. Welcome Sarah. Thank you so much for having me. Yeah, I think we're going to have a great [00:01:00] time talking about pension plans today. Sarah has 10 years of experience helping business owners navigate the complexities and maximize the advantages of retirement plans.
She holds multiple retirement plan designations including qualified 401k administrator, accredited investment fiduciary, and certified plan fiduciary advisor. That's a mouthful. It is. Yes. Alphabet soup. Yes, it is. But you've got lots of letters after your name, which is always good. So we'll just dive right in.
So thank you so much for being here. Well, thank you for having me. Uh, we met, I met Sarah. Uh, we have these conferences or meetings, I guess I should say, where there are companies that just do pension plans for businesses and they will run all of the numbers, uh, and make sure, you know, basically tell you how much you're going to save in taxes and how much it's going to cost.
And then they help you implement them. And that is how Sarah and I met. Yep. Yeah. So let's just get started.
Deciding When to Implement a Retirement Plan
Um, I kind of wanted, let's start, actually, I was going to start [00:02:00] with the simpler plans, but why don't we back up even if you're a business owner, when might you want to, is there like a, a time when you would know that you want to implement a plan?
Yes, uh, oftentimes your CPA might clue you into the fact that you've got some extra income that you might want to consider sheltering from taxes. Um, otherwise, you might find that it's time to offer employee benefits for retaining and attracting talent if you have employees. So, you basically want to ask yourself, you know, do I have some extra income or do I have employees?
And then, of course, depending on what time it is during the year, there's different deadlines for training. different types of strategies and that might affect your decision as well. Right. Okay. And would you say that you, I mean, obviously you want to go meet and talk to someone before these deadlines. Uh, but you're just saying most of the time it's when a CPA says, Hey, you've got some extra income.
You're going to want to save some taxes. And then they come to you. [00:03:00] Oftentimes, oftentimes. And it depends on the size of the company as well. Whether you're a, Now a sole prop or an LLC tax is a corporation or if you're a corporation with several employees and if you have over 100 employees, that's gonna change what strategy you use as well.
Yeah, you can't use all of these retirement plans that we're talking about. Some of them are geared towards the very small and then other ones as you get bigger, you, you're. Don't even have the option to put these other ones in place or they really become cost prohibitive. Right, exactly. Yeah. Exactly.
Yeah. So your entity type and how many employees you have and, uh, you know, how much you can put away is gonna determine what the best strategy is. Yeah, and I'm really big on the retirement plans of. I see a lot of plans that are put in place for people that, you know, the business owner is already busy and then they have these really complicated like db uh, cash balance plans put in place, and, uh, defined benefit.
That's what I'm saying with a D DB plan. So [00:04:00] in these different kinds of plans, you can put a lot of tax savings, but then they are just so overwhelmed with the amount of fees and the amount of time that it takes to manage some of these. Um, plans later on down the road, like they're excited about it and the first time that they do it, but then we get into like year three and four and they're just like, what did I do?
I mean, I'm paying all of this money and it's just all this reporting. And so do you find that too sometimes? Like, I think I'm just saying, I think it's important to match it with that. Absolutely. And for cash balance or defined benefit plans, I think it's, it, yeah. fits a certain type of business owner. Um, typically I would say over the age of 60 with a couple of employees that are a bit on the younger side and you have to be committed to that plan for about five years because the benefit is defined.
So you have to make sure that you're going to be able to fund that plan for that many years. For that many years, we say five years, that's probably a little bit conservative. Um, Uh, but with [00:05:00] that outlook, you won't run into issues over underfunding and, uh, yeah, cash balance plans in particular, um, when they fit, they're a tremendous fit, but they are not for everybody.
Yeah, they're not for everybody. And to your point, it's very smart to definitely take a look at how much they're going to cost, uh, because typically they can be in the, you know, on average, And I hate throwing numbers out there, but probably around 5, 000 a year to administer it. So you want to make sure that you really have tax advantages lined up in order to implement one of those plans for five years.
And that it offsets the cost of the plan and the time that you're going to spend on it, getting all the documentation and, and, you know, emailing somebody like me and saying, Hey, let's send in the. You know, the statements for 1231 or whatever date it is, but I'm kind of jumping ahead of myself here with the, because I just jumped to the most complex plans that there are out there.
Uh, but I, my point is, is that when you are going into this, I find it very, [00:06:00] very important to match it with the cost of the plan and the time that it's taking to implement. You know, I've got some people that, you know, want to do a 401k plan, but they're already running around like a chicken with their head cut off and they don't have anybody to help administer the plan.
And so sometimes we talk to them about different plans. So we are going to go over all of the different plans that you can implement when you have employees, or even if it's just you, like a husband and wife team.
Exploring Simple Retirement Plans: IRAs and SEPs
So, um, the first one that I would like to start with that, I think obviously you can just do IRAs, okay.
Those are retirement. You know, options that you could do. Um, and then going into the simple IRAs. Yes. Okay. So simple IRAs, you do not need someone like Sarah to implement it. Uh, you would just come to somebody like me, a financial advisor, or you could just do it on fidelity. com or, you know, Schwab. com and those have a maximum.
I believe this year is 17 and a half, 17, 500 is the max that you can put in. [00:07:00] And, um, when you have a simple. And you have other employees. Usually what people do is they put in 2 percent of their, uh, salary of the employee's salary. So they're very easy to administer. It's just like your IRA. You can put in all this money when you're filing your taxes.
It's just that instead of like that 7, 000, you're able to put in, you know, 17, 000, depending on your age, obviously. If you're over 50, then there's more. We could get into all these different caveats. This is why Sarah and I have jobs is because every situation is different and the different laws apply. So the next one, would you say is a SEP IRA?
Yes. Yes. So there are simples and there's. SEPs. Uh, the big difference being that, you know, to your point with simple plans, you, you can, uh, set up a simple for your employees and they can defer as an employee and then you make an employer match or contribution. Uh, with a SEP, it's just an employer [00:08:00] contribution.
So, uh, if you have any employees, they cannot defer anything, uh, to their, for, to their SEP account. And as a business owner, you technically cannot defer anything either as an employee. Um, and you're capped at 25 percent of your wages. is the maximum employer contribution you can make, and it has to be the same contribution to yourself as the owner and to your employees.
So if you're going to give 25 percent to yourself, then you're on the hook for 25 percent for your employees as well. So you might be asking, you know, when would anybody ever set up a SEP? Um, oftentimes, And one strategy that's interesting is if you are already employed and you have a 401k plan through your employer and you are maxing it out as the employee, and then let's say you have a consulting business on the side, um, in which case you might want to set up a plan under that business.
and make an [00:09:00] employer contribution of 25 percent to yourself. You might not even have an employee or maybe one of your kids works for you or you have a part time employee and you know, you can afford to give them that 25 percent based on their wages. Um, in which case then you can have the 401k as an employee through your employer and then, uh, have your own business SEP account.
And you can contribute 25 percent that way. That's a great strategy. Yeah. Yeah, thank you. Okay, uh, and a lot of people, yeah, they don't opt for the SEP if they have a large company, obviously, because they want to put in a lot for themselves, but not 25 percent for their employees. Exactly. Yeah. Exactly. But SEPs, like SIMPLES, uh, you don't have to deal with any reporting requirements, like a form 5500 that you might associate with a 401k plan.
Um, so they're very simple. They're usually pretty inexpensive and they're easy to set up. Simple's have a deadline of October 1st, but a SEP, because it's just an employer contribution, you technically [00:10:00] have until the filing of your corporate taxes. So for 2024, going into 2024 now, uh, you can still take, uh, set up a SEP and make a contribution for the 2023 tax year and, uh, make that contribution before your.
Taxes are due. Right. Okay. And then on a simple, uh, there are different ways. I was simplifying it when I said there's just 2%. Um, I just think that most people do that just to make it easier, but you can have a sliding scale of one to 3%, correct? Correct. Uh, you can have, let's see, for a simple, you can make a 2 percent contribution to your employees and that's just a straight 2%.
That's not a match. They have no skin in the game. And no matter what you're putting in 2%, it's called a safe harbor. Contribution. And then you can also, uh, for a simple have a 3 percent match. So that does require employees to have skin in the game. Right? So if they were going to defer some of their [00:11:00] income, then you could do, oh, I think, isn't it one to 3%?
It's 3%. 3 percent total. 2 percent contribution or a 3 percent match. Okay. And a lot of people I've found don't want to do the 3 percent just because they don't want to go through the hassle of figuring out what people contributed and they're like, well, forget it. We'll just do 2 percent and call it a day because it doesn't end up being that much for them to be able to put in the maximum amount.
Exactly. Exactly. Okay. And a 2 percent contribution is cheaper than your your traditional 401k plan. Right. That makes SIMPLES that much less expensive as well. Right. Okay, so those are the two simplest talking about simple IRAs and SEPs, but, and I think those are really, really also very simple because you do not have to file anything with the government every single year.
And you're not having to have a record keeper, um, which is just another company that is keeping track of the contributions and they're doing testing. Is that correct? Or how would you describe a record keeper? Right, right. A record [00:12:00] keeper is a provider to a 401k provider. Plan that basically tracks the assets and tracks the money sources because you can have traditional, you can have Roth, there's employee sources, employer sources, potentially profit sharing, safe harbor matches.
So it gets a little complicated. So they track the assets. Uh, the record keeper provides that website, that participants log on. You can, uh, change your investments, your deferrals, all that good stuff. Yeah. And then the administrator works in partnership with the record keeper. Sometimes it's the same institution.
Sometimes you have a. third party administrator, but they're the ones that are going to be doing the calculations and the valuations and filing that 5, 500 on your behalf, uh, and just keeping you in compliance. Okay. Okay.
Diving Deeper into 401k Plans and Profit Sharing
So yeah, so let's get into 401ks, obviously. So, uh, these are the most popular plans that people, most people are familiar with and 401ks are the first step.
step that you're getting into of having to file with the government and have a record [00:13:00] keeper and a third party administrator. Um, and what would you say to a business owner about a 401k? That is a great question. So if a business owner was, uh, trying to determine if they wanted to start, say a simple or a 401k plan for their employees.
Um, for starters, I would ask, you know, how much do they want to put away as the business owners? How much can they defer off the top of their own wages? So if they're paying themselves 100, 000 in 2024, they can technically defer 23, 000 from taxes. If that's attractive and doable, And they're objective, then I would say definitely a 401k plan.
If they're over the age of 50, they also get to defer an additional 7, 500 as a catch up. And then there's a lot of flexibility with the type of employer. Contributions that can also benefit the [00:14:00] owner, whether that's a match or a contribution, profit sharing. And then if you want to take it even further, and if it's the right fit, you can tack on a cash balance plan and really maximize an owner and, you know, Potentially they can put away 300, 000 if it's the right fit.
So 401k plan is the strategy that allows us to really maximize, uh, the tax advantages to owners. So with a simple plan, I think in 2023 or 2024, I'm sorry, the limit's going to be 19, 000 and then 3, 500 in catch up. So if, If realistically ownership says, Hey, look, you know, I, I think I can only put away five or 10, 000.
We can look at a SEP or a simple, I'm sorry, versus a 401k plan. Um, so that's step one. And then step two, of course, is your employees themselves. [00:15:00] Depending on how you want to benefit and match and contribute to them as well and maximize. Um, a lot of owners right now, they, they want to open the 401k plan because of the flexibility in giving, uh, potentially a lot more to their employees.
So that they can attract and retain talent as an employee benefit. Yes. Yes. And then you can also use profit sharing as a type of almost, for lack of a better term, golden handcuffs. Because you can put a vesting schedule on, um, certain employer contributions. Whereas with a simple, uh, Uh, the, the employees automatically own 100 percent of that employer contribution or match, right?
You get a little more flexibility of 401k plan, you could make a profit sharing contribution to your employees and they might have to stick around, you know, five or six years to have ownership of that money. If they leave before then, they forfeit it back to the plan. So can you explain the difference between a profit sharing contribution and [00:16:00] a matching contribution?
Sure. Sure. So when you set up your 401k plan, you know, you decide what kind of employer contribution you want to make. A lot of business owners will, you know, Uh, use a safe harbor design, which you touched on earlier, which is basically an IRS formula where you automatically pass all the pesky testing so that the owners can maximize themselves.
And I call a safe harbor contribution. It's a deposit that you can't take back. I mean, you are, you're giving it to your employees and you're not taking it back here. It's, it's. It's there's no vesting schedule. There's no option for any of that. It's, um, you're giving them money to put into their 401k account.
Yes, it's basically 100 percent their money. And in most cases, even if an employee leaves before the end of the year, uh, they are entitled to that safe Harbor contribution or that match. So yes, to your point, I mean, it is money that you are giving to them. Um, versus a [00:17:00] profit sharing contribution, which is a, a different type of, of money source.
Therefore, there is going to be some testing requirements, um, and there's different. What do you mean by testing requirements? So testing, uh, non discrimination testing is something that all 401k plans are subject to. And it's basically the IRS wants to make sure that the benefit is proportionate between ownership and the employees.
They don't want to see owners just setting up plans, uh, taking advantage of, of whatever, um, you know, sheltering tax advantages. Putting a bunch of money in there and then having no one else participate. And then having no one else participating or no one else even knowing about the plan. That's why we have these testing requirements and these notice requirements.
Um, and in this instance then for profit sharing, Um, an owner can [00:18:00] maximize themselves even more. They can make a profit sharing contribution to themselves up to a different limit. So in a 401k plan we talked about as an employee, the owner can put away 23, 000. And that's salary deferral. Salary deferral.
So whatever you pay yourself you're just taking some of it and putting it into the 401k. And then there's the other portion of it, which is Which is going to be the profit sharing. Right, right. Um, and that's an employer contribution, so you have your employee bucket, you have your employer bucket, and that for 2024, between the two of them, the limit is 69, 000.
So 23, 000 can go into the employee bucket, and that's going to be deducted each pay period, or however you set it up, but that's what we would recommend. And then at the end of the year. The employer can make profit sharing and that would go into the employer bucket up to a total of 69, 000 between both sources.
Um, And would you, you [00:19:00] don't call that matching because profit sharing is up to the discretion of the employer. It's, it's discretionary. And depending on what type of formula you use, um, it could be subject to testing. So ultimately, you know, an owner might want to maximize themselves and maybe they can, but they're going to be on the hook to also make a contribution to the rest of their employees.
Um, and in order to get that maximum amount in, they've got to contribute a certain amount to all the employees. Yes. In order to get that maximum amount. And typically. It's a 5 percent contribution to the employees and that is, uh, between whatever Safe Harbor contribution you make. And then any additional contribution and it's, you can't generalize it because again, we're trying to pass testing and occasionally if you have an older employee, you might have to give them a little bit more because they're older.
Exactly. So that's where your administrator [00:20:00] at the end of the year can run an illustration and say, Hey, owner, this is how much it's going to cost you. You can maximize yourself up to this amount and that's based on your compensation, based on your age. But you're also going to have to give your employees, you know, a little bit of money here and you can run the illustration, see if it makes sense.
Uh, and you can decline it cause to your point, it's completely discretionary, but that's just a different type of employee your contribution. You can make it a 401k plan and then you can attach a vesting schedule so that whereas the employees are going to have a hundred percent of that, uh, safe Harbor match or contribution.
You can attach, you know, a five to six year vesting schedule that basically says an employee has to stick around before they have 100 percent ownership of that profit sharing contribution. Okay. And so does an employer have to, uh, choose between doing a profit sharing or a matching? Um, no, it's because they could do [00:21:00] matching all year long, right?
Sure. And of 3%, you know, they do all kinds of things up to 6 percent or 50 percent of up to 6 percent stuff like that. Oh yeah. Oh yeah. We can get really creative with the type of employer contribution you are giving. Um, however, as the owner, if you want to hit that 23, 000 number in 2024, you want to consider a safe harbor plan.
Pass, pass that testing automatically and then, uh, you'll be able to, um, make either a match or a contribution to your employees that the matching formula, it's a little confusing, but it's basically your employees would have to defer 5 percent of their pay into their 401k account. To, uh, to get the employer match, um, the maximum employer match of 4%.
So think of it as a business owner. You are on the hook for 4%. And so why would someone choose to do [00:22:00] so? Do most people choose to do the profit sharing? Is that what you're saying? Instead of the matching? Um, just so they can get the maximum amount in. Well, you can do both. So at a baseline, you would choose a, you would set up a safe harbor plan.
If you know for sure that you're going to be making a profit sharing contribution, there's a different safe harbor formula that will let you pass all the testing, and it's a 3 percent straight contribution to your employees. Whether they have any skin in the game or defer into their 401k or not, you can give those employees that are eligible a straight 3 percent of their wages.
And the reason being is that 3 percent is going to help you pass that 5 percent gateway test so that you can put the maximum amount into your own account. Yes. Okay. And typically, uh, you can only max out on the profit sharing if you pay yourself enough. Because it is a formula, it's going to be based on potentially, uh, the maximum comp.
Uh, and I [00:23:00] think that the IRS does limit compensation in a 401k plan that can be used, you know, that can be considered for these various formulas. I think in 2020, For it's 350, 000. I'll have to confirm that. So you want to make sure that you're paying yourself enough so that you're, because you get, it's not like you're going to pay yourself 50, 000 and then defer 50 percent of it or 100 percent of it.
Right. That's what they don't want to see. No, not necessarily. Not for profit sharing. Right. I mean, you could pay yourself 50, 000 and defer the 23, 000. In just a traditional 401k plan, a safe harbor plan, um, but then yeah, if you, if you want to, uh, maximize the profit sharing and maximize that employer contribution bucket, then you're looking at paying yourself more.
Maximizing Your 401k Contributions: A Guide for Business Owners
Okay. And that's where an administrator can help you with those, uh, profit sharing illustrations at the end of the year. Um, and that's why it makes sense to get started a little bit earlier in the year and talk to your CPA, [00:24:00] um, because, you know, we see so many times business owners run up against, uh, you know, Oh, I, I didn't know it's December now and I should have paid myself more because, you know, I didn't get the maximum employee deferral.
You've got to be making those employee deferrals before 12 31. Um, and then, you know, I didn't pay myself enough now to maximize in profit sharing. I mean, even if you have until your corporate deadline, you've got to pay yourself enough during the year in order to be able to, you know, maximize. Yeah, and I remember so when I was studying, it made it much easier for me to remember that your employee contribution, whether you're the owner or an employee of the company, that is salary deferral.
And you need to think of it that you are paid between January 1st and 1231. And so you can't be putting away your salary in April of the next year. That's when you're matching and all of your profit sharing goes in. And so that's what made it very, um, it made it stick in my head is just that you get [00:25:00] paid in that year.
And that is when, in that year that that money needs to go into that plan as a deferral, as a salary deferral. And you need to make sure that you're getting enough in there so that you can then get the matching or get the profit sharing portion of it. Right, right.
Understanding Safe Harbor 401k Plans and Deadlines
And for a safe harbor 401k plan, again, that lets you pass all the testing.
The deadline to have that all set up is October 1st, but you've got to have it completely set up and be running payroll successfully by, you know, your first payroll in October. So you really want to get it started in the summer, right? Because it might take some Six weeks, six to eight weeks to get everything set up.
Yeah. It takes a long time. And when you're setting up and, and if you were rolling over a 401k, it takes a long time, another plan, and you were going over to, uh, a new company that was going to manage it, that also takes months. Yeah. So this is not a short process. nos. A lot of tests. There's a lot of, um, paperwork to sign, a lot of, um, people that are talking to each other to [00:26:00] make sure everything is on the up and up.
Exactly.
The Process of 401k Conversion and Record Keeping
And what you were talking about is a 401k conversion when you're changing record keepers. That can be about a three month process. And, uh, another thing to consider, if you're already a Safe Harbor plan though, uh, you don't have to worry about any deadlines. You're just changing your service providers.
If you are starting a 401k plan, then you've got to be on the lookout for that October 1st deadline if you want to be Safe Harbor and pass the testing. Okay. So. All right. I would say kick it off in the summer. Yeah. And maybe even start in the spring. Yeah. Yeah. But, I mean, potentially. Preferably now. Yes, it's just to make sure that you're going to pay yourself into, you know, in the next year and that you're going to.
Yes. And do you see that a lot where business owners aren't paying themselves enough to get money into the plan and that you have to tell them to increase their salary? Uh, yes. You see it more often than not. Um, a lot of them are kind of surprised, especially if they've got [00:27:00] an S Corps, uh, or, or they're taxed as a corporation.
And, you know, it makes sense that maybe they're only paying themselves 30, 000 to 50, 000. And they think that they can use their K 1 distributions, uh, for their 401k plan, but you cannot. So that's where It has to be salary, just like what I just said, your salary deferral, you have to have a salary in order to defer it.
Yes. And, uh, a lot of business owners, they'll, they'll rush through the end of the year, and they'll, they'll have to bonus themselves, and it has to be. To be run through payroll in order to try to maximize those employee deferrals. But then you've got a big chunk of money at the end of the year, you're rushing in and you're just hoping the market's down that day.
Uh, versus if you get started earlier in the year and you just have steady payroll deductions, then you kind of average into the market, which is, you know, more advisable. Right, right. Okay. And so do you think we've covered 4 0 1 Ks at a top level at a good amount. Is there anything else you wanna add?
Let's see. Uh. [00:28:00]
Federal Tax Credits and State Mandates for Retirement Plans
For 2023 and 2024, um, there are some really attractive federal tax credits if you want to start a 401k plan, or a SEP, or a SIMPLE. Um, and it's basically one tax credit is a plan expense credit, it offsets your plan expenses. It's basically 250 bucks per eligible employee. Up to 5, 000. Oh, wow.
Yeah. And then there's the automatic enrollment credit, which is if you add, you know, automatic enrollment to your plan design, which we would recommend because it's going to be required in 2025 anyways, you get an additional 500. And then there's the employer contribution credit. Which you actually get a credit up to a thousand dollars for employees that you're making some kind of match or contribution to.
So there, there are a lot of great incentives. I mean, that sets a lot of costs. Yes. It's unprecedented. We've never seen that. Yeah, it is. I've never, yeah. And [00:29:00] so there's also state mandates out there, um, and I want to say over, you know, 30 states right now either have an active mandate or pending legislation that's going to require employees to have access to a retirement plan or be enrolled into some kind of state program.
And most of them are just a type of Roth IRA account, um, but between the mandates and then the federal tax credits, I mean, now is, I would say in my opinion, the time to set up. Yeah. There's no better time to set up a 401k. There's better time. Yeah, I agree. To set up a 401k plan.
Choosing Between 401k, SEP, and SIMPLE Plans
And where SEPs and SIMPLs, they're, they're inexpensive.
Um, if you have the employee base and you can get that 5, 000 credit to offset starting a plan, um, I would start a 401k plan. Yes. So, there's more flexibility, um, just, just much more design flexibility. And it's kind [00:30:00] of, I mean, based on, you know, public opinion, it's kind of the, the retirement darling of the works.
Everybody knows it. Yes. Everybody knows a 401k plan versus a simple plan. Um, a lot of times people will start with a simple, but then they outgrow it. Because they get too many employees. They get too many employees, uh, they need more flexibility. Maybe employees What do you mean by more flexibility? They need more flexibility in what?
In being able to put more in? For themselves? Potentially, yeah. Having the higher contribution limits, but things also like loans. So a simple plan, you cannot have loans and everybody's immediately vested. Um, and up until recently you couldn't have any kind of Roth deferrals. That has changed. Um, and that might change the marketplace a little bit because that was always one reason I found simples unattractive is you could not.
There was no Roth option. No Roth option. Yeah. Now there's a Roth option. So that changes things. But And those are becoming really [00:31:00] popular. Yes. People, when I talk to people about where they want to save, um, if they're not doing a hundred percent Roth, they're doing like 50 50. A lot of people love the Roth.
Definitely. Definitely. So it makes sense to finally have a Roth option in simple plan. But then, uh, I mean, we're still waiting on IRS guidance actually, because we don't know exactly what that's going to look like. Yeah. And they have a Sep Roth IRAs too, but that guidance hasn't come out either. So hopefully we'll see that in the next year.
Yeah. That's a little bit of a game changer. Yeah. But then still on the 401k front, um, you have the flexibility with employer contributions, investing in profit sharing, and potentially adding that cash balance plan and what have you. Um, Um, so if you've got a lot of benefit to the business owner, a lot of benefit to the business owner.
If you can, uh, get the tax credits to offset the plan expenses, it makes sense to just start the 401k plan. Um, those credits are for the first three years you start the plan. Oh boy. Right. [00:32:00] So if you, because 401ks are more expensive than simples, if you have the option, just start the 401k plan and take it, especially now and take advantage of the, yeah, yeah.
Yeah. Yeah.
The Importance of Financial Advisors in Managing 401k Plans
If you start and what would you recommend then for the people that I have come across that do, um, it's mostly been with the more complex plans, but if they are running around, I mean, they barely have time to run their businesses and they do want to do, cause I've had people not implement anything cause they're like, this is just too much.
I can't implement anything. Uh, and if they do implement a 401k, what would, do you think that they need to hire someone else to Manage it because there is that, there is that portion of where you have to actually speak to your employees. Yes. Is that, do you have any recommendations on that? Oh, for sure. Um, I mean, I would definitely recommend working with a financial advisor, for sure.
And you think that, that then just the advisor can, I guess, uh, what am I trying to say? Like loop that [00:33:00] bridge, that gap that's there. Yes. Yes, definitely. Especially, I mean, if, if the business owner is already busy as it is, um, it's wearing the 401k hat is it's definitely, it has a learning curve. Yes. Um, and so working with somebody who's a specialist and who can be a point of contact with the business owner and help them with that service provider selection, Um, and help get the employees Yes.
And en engaging up, up, and running. So you're getting them, uh, enrolled, you're making sure they know where they can log in and then what kind of investments to pick. Things like that. Yep. But I think where the day-to-Day comes in is, Hey, I wanna take a loan. Hey, I wanna, you know. Change this. I want to change from contributing 10 percent to 12%.
Those kinds of things. But a lot of that can be done online now. I mean, they would just log on and do it. Absolutely. Absolutely. So the advisor to your point with, uh, can help with employee engagement, education, um, But at the same time, there are service providers that [00:34:00] are going to reduce that administrative workload more than others.
You might have heard the term 316 fiduciary, that's just fancy talk for, um, an administrator that will approve. The loans and the distributions and and it can really help with the day to day administration of the plan and keep the plan in compliance. Um, they're not all created equal. Some reduce your fiduciary more than others.
Some are full 316 and they'll sign the 5500 and they'll actually assume, you know, more of a plan sponsor role, whereas others are more 316 light. But it still reduces that day to day workload, uh, that in the past probably five years we've seen the change where, where business owners are finding that these, uh, these These 316 offerings are so attractive, and they're making that shift.
Good. We needed it because these business owners were just drowning in paperwork, and [00:35:00] it's not something that, you know, they want to work on their business. They don't want to be administering the 401k and whether, you know, Joe needs a loan or withdrawal. And whether they're in compliance with it, right.
And did Joe get all his notices? So that's where, in this day and age, I would recommend working with some kind of 316. That's going to reduce that workload. Yeah, because when you have a 401k, you have to make sure that you're giving the employees notices about the options of the plans, whether they're getting a safe harbor, contribute, you know, they need to know what's going on and that it's an option and what the options are inside the plan.
Right, right. And just making sure that the plan is running on time. Uh, per the provisions of the document. So I mean, as a business owner, do you know exactly what the eligibility is and the vesting schedules and everything else? Yeah, and you're going to forget it after a day of being outside of the meeting.
Exactly. Yeah, when you set it up. So working with the right service providers. Also I would say the most important thing in this day and age is your payroll provider and how well they integrate with your 401k [00:36:00] platform or not. Because that can make it very easy. Oh yeah, it can make it a lot easier. And, uh, if they don't integrate, is it an easy process to manually upload those contributions?
Uh, and can you do it timely as a business owner? And that's where we probably see the most corrections in a 401k plan is, uh, employers, you know, they're, they're holding onto those, those 401k contributions, maybe a little bit longer than they should be. When they're processing their own payroll. Yes. Okay.
Yes. So, uh, so many providers now have that full integration. So if I was looking to set up a 401k plan, I'd want to make sure I was working with a 316, that I had payroll integration, that I was working with a financial advisor so my employees would be educated and engaged and so that they would know the value of the 401k plan as well.
And, uh, just to make sure you can, you know, for starters, keep the plan in compliance and then have a team behind you to help make sure that you can maximize yourself as the owner. [00:37:00] Yeah. Okay. And then, okay, so, uh, I think we've talked a good about, about 401k plans.
Exploring Cash Balance and Defined Benefit Plans
So now we can go on to cash balance plans, or do you want to start with the DB plan?
Define benefit. Well, they're, they're almost one in the same for the most part. Um, the industry's leaning towards cash balance, cash balance plans. They are a type of DB plan. It's a defined benefit, but they, they act and they feel a little bit more like a 401k plan. They're more portable in case you leave the company as an employee.
Um, but the, the, the takeaway from from a cash balance plan, uh, that I think business owners need to know is that those plans can only grow at a set percentage. So it's usually about 5 percent is. So if you made more in the stock market than 5%, then you can't contribute anymore. Exactly. Exactly. So then.[00:38:00]
The plan would be considered overfunded. Let's say it made 10 percent and then you're getting as the owner less of a tax advantage because you're not able to contribute as much. Or if the plan, you know, doesn't grow, what if you get negative 10 percent returns, then as the business owner, you're going to be shelling out additional money.
Because the plan is underfunded, so it's kind of hitting that sweet spot of, you know, you've got a funding formula, and then you don't want it to grow more than about 5 percent a year, so it's really important to be working with a financial professional, a financial advisor, For a cash balance plan. Yeah, make sure you're hitting that 5 percent target and that there aren't any surprises and business owners should know that they've got to have that consistent income for those five years.
And so the reason that someone would put a cash balance plan would just be they have extra income that they're trying to save money or is trying to save taxes. And then they also have enough [00:39:00] money that they can give a benefit to their employees. Yes, yes. But it's really only the top employees, correct?
Well, it's any eligible employee, really. Oh, I've seen a lot of them where they only do a lot of the top, like the management. I wouldn't say top, top management, but you know. Yes, you can structure it that way. Um, the most, I would say the best fit I see is going to be, An employer who's a little bit older, again, about, you know, 60 years, and they might have just a couple younger employees that are eligible, um, and you've, you've got to consider also, does your family work for you, because that's, you know, they're considered a highly compensated employee, same as the owner, um, and that can skew the numbers too, so you might be thinking of, of targeting, targeting, targeting, Ownership in particular, um, whether that's [00:40:00] family members or somebody, you know, making over 150, 000 is also considered a highly compensated employee.
And so, yes, you, you can carve them out and try to, uh, contribute as much as you can. Um, from their wages as our shelter as much as you can from their wages and with owners, we can see as, you know, up to, gosh, 300, 400, 000, even that can be sheltered. Um, but then you are on the hook to give, uh, the, uh, Non highly compensated employees.
Again, those are folks not making 150 grand, who are not, you know, immediate family members of the owners, who do not have any ownership. Your rate and file employees, uh, they, they do get a small percent, and that can be anywhere from, I mean, Two to 10%. It really depends. Um, back to testing. It depends on how much you want to put in.
It depends on how old you are and what your [00:41:00] salary is. I mean, there's a lot of factors that go into this. Yeah. Basically the closer you are to retirement, you have a shorter time horizon and the IRS says, okay, owner, you know, you're going to retire, you know, technically based on the formula, let's say five years.
So we're going to let you put away more than six months. Say if you had a much longer time horizon and you were 21 years old, in order to hit that same retirement target, you know, you only have to be put in a little bit every year. So that's where your younger employees, you're just putting a little bit in for them to, to, you know, match that target, meet that target.
And then for the owners, they might have a similar retirement target, but their time horizon is much shorter because they're older, so they get to put away more. Okay. And then what would be the difference of a defined benefit plan versus the cash? Defined benefit plans are typically used when you have an owner only.
So, it's because they're [00:42:00] less portable than, say, a cash balance plan. When we see employees involved in a business, we prefer setting up the cash balance plan. If it's owner only, maybe owner and spouse, then you can set up a straight defined benefit plan. Um, you can set it up, you can structure it as a cash balance plan too, but, I mean, at the end of the day, it's up to you.
Without having the employees. So if it's just a single owner and maybe the spouse, you could, could you do like a individual 401k and a defined benefit plan? That's exactly how you together, yep. That's how you would do it. Okay. That's, that's how you would, that's how you can structure it. You don't have to actually, yeah, you don't have to, but you could.
You absolutely could. So then you get the employee deferrals. And then you can also max out that employer bucket up to 25 percent of the wages on a solo 401k plan. And then you can tack on that cash balance plan for, you know, depending on their age and the formula used, put, put away another 250 to 400, 000.
Yeah. [00:43:00] Yeah.
The Necessity of Professional Guidance for Complex Retirement Plans
I think the moral of the story is if you want to do anything other than a 401k plan, you need to call someone like Sarah or a pension plan specialist. Specialists that can run some formulas for you and tell you how much it's going to cost to implement and how much you're going to be able to save.
Definitely. Yeah, it's not something that you can do on your own. I mean, it requires an actuary. I mean, there's a lot of stuff that goes into it. Yes, for sure. Um, and it's going to be a little bit more expensive to administer, but you know, we see that the, the, it might be well worth it. The cost might be well worth it with the tax savings.
Right, right. Okay. Uh, am I missing any retirement plans? Yes. Ooh. Well, I mean, we could get really granular, but for the most part though, yeah, I don't wanna get into nothing. I would recommend, yeah, I don't wanna get into 4 0 3 Bs or you know, anything. If you have a 4 0 3 B, it just means you work for a nonprofit, correct?
Yeah. I mean, it's a 401k, but you work for a nonprofit, so there are all these different names and jargon out there, but most of the time it's a [00:44:00] 401k. Or an IRA, right? It works exactly the same. Yes. Yes. Uh, 403B would, uh, for the most part, I think we've covered the ones that I would recommend. Okay. Generally recommend to a business owner.
Yeah, I agree. So, well, thank you so much for being on. I really appreciate all of your knowledge and I've learned quite a few things today. So thank you. Y'all. Thank you. I appreciate you taking the time to come out and everybody, uh, let me know if you have any questions. Sarah's information will be in the show notes if you, uh, need to contact anybody or you can contact me with any questions and be sure to review the show or subscribe and tell your circle of friends if you would.
Thank you so much for listening.
Disclaimer: The information provided in this podcast is for general informational purposes only and should not be construed as professional financial advice. Always consult with a qualified financial advisor or professional before making any financial decisions. The hosts and guests of this podcast are not responsible for any actions taken based on the information presented.