Retirement Plan Options for Business Owners
Many businesses are experiencing record profits these days, despite a tight labor market and softening economy. Offering a company-sponsored retirement plan can help reduce income taxes for business owners while also serving as a valuable retention benefit for employees.
As of June 30th, 2022, employers in California with five or more employees are now required to either sponsor their own company retirement plan or enroll in the state’s mandatory CalSavers program. Under recent legislation, this mandate will apply to employers with one or more employees starting December 31st, 2025.
Failure to comply will result in penalties starting at $250 per employee.
In this post, I’ll provide some details about the CalSavers plan as well as discuss some options for creating your own plan.
1. Set Up Your Own Company Retirement Plan
A popular 401(k) option for small and mid-size businesses is a Safe Harbor Plan. The deadline for adopting a new Safe Harbor 401(k) for calendar year 2022 is approaching on October 1st.
For those looking for larger retirement plan contributions, a 401(k) Plan can be paired with a discretionary profit-sharing plan and a defined benefit pension plan.
Why a Safe Harbor 401(k) Plan?
A Safe Harbor Plan works like a traditional 401(K) plan in that owners and employees alike can elect to save $20,500 ($27,000 for those 50 and over) per year into their retirement account. Employees can choose pre-tax or after-tax Roth contributions (with no income limitations) and assets in the plan are typically protected from creditors.
In a traditional 401(k), however, owners and highly compensated employees are often limited in their contributions based on the overall participation rate of all eligible employees.
The Safe Harbor provision requires the company to make a minimum contribution or match to eligible participants, but in doing so allows owners and highly compensated employees to max out their deferrals regardless of overall company participation in the plan.
The two commonly used Safe Harbor company contribution options:
- 3% Non-Elective Safe Harbor - Provide a 3% profit sharing contribution to all eligible employees. This 3% can also do "double duty" as it can be counted as an offset for new comparability profit-sharing plans.
- 4% Matching Safe Harbor - Offer non-highly compensated employees a $1 for $1 match up to 4% of income (may increase match to 6% of pay and may include highly compensated).
Safe Harbor contributions are tax-deductible to the company and 100% vested immediately to the participants. Owners have found this trade-off extremely worthwhile. By electing a Safe Harbor, they are allowed the maximum deferral, they too receive a company contribution, and they reward their employees while helping them save for their retirement.
Startup Plan Tax Credit
Employers can now earn up to a maximum $15,000 tax credit spread over 3 years for adopting a plan.
Can You Put Even More Away on a Pre-Tax Basis?
For owners with significant potential profits and thus tax liabilities, a Profit-Sharing Plan can be paired with a 401(k) plan. There are several methods for calculating profit sharing among the pool of eligible employees, but contributions can oftentimes be skewed to owners and select employees. Company profit-sharing contributions are tax-deductible and are not required annually. Adding this option to a plan simply allows for discretionary contributions in high profit/high tax years.
What is a Defined Benefit Pension Plan?
For highly profitable companies with consistent cash flow and profit we have seen great success in implementing a third retirement plan component, a Defined Benefit Pension Plan. Defined Benefit Pension Plans often allow for significant pre-tax contributions, sometimes hundreds of thousands of dollars per year.
They work very well in businesses with:
- Few or no employees other than the owners
- Union employees
- Medical groups
- Law firms and lobbying firms
- Older owners with younger employees
- Stable and predictable cash flows and profits
It’s important to note that the retirement plans discussed above come with annual administrative fees that can vary depending on the number of employees and the complexity of the plan.
As mentioned above, businesses that do not sponsor a company retirement plan and have five or more employees are now required to join CalSavers.
The adoption requirement has been phased-in since 2019 based on the number of employees, but the final deadline for those with five or more employees just passed on June 30th, 2022.
There are exceptions to the requirement to join CalSavers. Excluded from participation are sole proprietorships, self-employed individuals, and other business entities that only employ the owners of the business.
Those employers required to join must register for the program, upload employee information, and submit employee contributions via payroll deduction.
Some highlights from the CalSavers website:
- Employee participation is voluntary, though employees are automatically enrolled to save 5% of each paycheck unless they opt out.
- Only Roth IRA accounts are offered with a maximum annual contribution of $6,000 ($7,000 for those 50 or older). Unfortunately, like Roth IRAs the ability to contribute phases out based on Modified Adjusted Gross Income ($129,000-$144,000 Single Filer; $204,000-$214,000 Married/Joint Filer).
- Accounts are funded by employees only (no employer fees or contributions).
- Fees to employees range from $.083-$0.95 per year for every $100 invested depending on investment choice.
Investment selections include:
- Money Market Fund
- Target Retirement Date Fund
- Bond Fund
- Global Equity Fund
- Environmentally and Socially Conscious Fund
Employers must decide on a compliance strategy - either establish their own 401(k), SIMPLE IRA, or SEP IRA or register for CalSavers.
For employers wanting to customize their own plan and maximize retirement contributions (and deductions), adopting a 401(k)/Safe Harbor/Profit-Sharing/Defined Benefit Pension will be more advantageous. Annual administrative costs will be higher under these plans. But, in the right circumstances, the benefits will far outweigh the costs.
There’s still time to consider which plan best fits your situation, but the October 1st Safe Harbor 401K) deadline is near.
Please reach out to discuss which plan - or combination of plans - is right for you.