IRS Releases Publication 3998 (10/2015), Choosing a Retirement Solution for Your Small Business
Publication 3998 (10/2015)
- Jurisdictions
- LanguageEnglish
Why Save?
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This publication constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996. It does not constitute legal, accounting, or other professional advice.
Starting a retirement savings plan can be easier than most business owners think. What's more, there are a number of retirement programs that provide tax advantages to both employers and employees.
Experts estimate that Americans will need 70 to 90 percent of their preretirement income to maintain their current standard of living when they stop working. So now is the time to look into retirement plan programs. As an employer, you have an important role in helping America's workers save.
By starting a retirement savings plan, you will help your employees save for the future. Retirement plans may also help you attract and retain qualified employees, and they offer tax savings to your business. You will help secure your own retirement as well. You can establish a plan even if you are self-employed.
A retirement plan has significant tax advantages:
• Employer contributions are deductible from the employer's income,
• Employee contributions (other than Roth contributions) are not taxed until distributed to the employee, and
• Money in the plan grows tax-free.
Any Other Incentives?
In addition to helping your business, your employees, and yourself, it's easy to establish a retirement plan, and there are additional reasons for doing so:
• High contribution limits so you and your employees can set aside large amounts for retirement;
• "Catch-up" rules that allow employees age 50 and over to set aside additional contributions. The "catch up" amount varies, depending on the type of plan;
• A tax credit for small employers that enables them to claim a credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE, or certain other types of retirement plans (more on these later). The credit equals 50 percent of the cost to set up and administer the plan, up to a maximum of $500 per year for each of the first 3 years of the plan;
• A tax credit for certain low- and moderate-income individuals (including self-employed) who make contributions to their plans ("Saver's Credit"). The amount of the credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent, depending on the participant's adjusted gross income; and
• A Roth program that can be added to a 401(k) plan to allow participants to make after-tax contributions into separate accounts, providing an additional way to save for retirement. Distributions upon death or disability or after age 59 1/2 from Roth accounts held for 5 years, including earnings, are generally tax-free.
A Few Retirement Facts
Most private-sector retirement vehicles are either Individual Retirement Arrangements (IRAs), defined contribution plans, or defined benefit plans.
People tend to think of an IRA as something that individuals establish on their own, but an employer can help its employees set up and fund their IRAs. With an IRA, the amount that an individual receives at retirement depends on the funding of the IRA and the earnings (or losses) on those funds.
Defined contribution plans are employer-established plans that do not promise a specific amount of benefit at retirement. Instead, employees or their employer (or both) contribute to employees' individual accounts under the plan, sometimes at a set rate (such as 5 percent of salary annually). At retirement, an employee receives the accumulated contributions plus earnings (or minus losses) on the invested contributions.
Defined benefit plans, on the other hand, promise a specified benefit at retirement; for example, $1,000 a month. The amount of the benefit is often based on a set percentage of pay multiplied by the number of years the employee worked for the employer offering the plan. Employer contributions must be sufficient to fund promised benefits.
Small businesses may choose to offer IRAs, defined contribution plans, or defined benefit plans. Many financial institutions and retirement plan practitioners make available one or more of these retirement plans that have been pre-approved by the IRS.
On the following two pages you will find a chart outlining the advantages of each of the most popular types of IRA-based and defined contribution plans and an overview of a defined benefit plan. Note: there is a new option -- myRA, a retirement account from the U.S. Department of the Treasury -- that is not discussed in this publication. For more information, visit myra.gov.
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IRA-BASED PLANS
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Payroll
Deduction IRA SEP
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Key Easy to set up and maintain. Easy to set up and
Advantage maintain.
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Employer Any employer with one or Any employer with one or
Eligibility more employees. more employees.
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Employer's Arrange for employees to May use IRS Form 5305-SEP
Role make payroll deduction to set up the plan. No
contributions. Transmit annual filing requirement
contributions for employees for employer.
to IRA. No annual filing
requirement for employer.
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Contributors Employee contributions Employer contributions
To The Plan remitted through payroll only.
deduction.
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Maximum $5,500 for 2015 and Up to 25% of
Annual for 2016. Participants age compensation1 but no more
Contribution 50 or over can make than $53,000 for 2015 and
(per additional contributions for 2016.
participant) up to $1,000.
See irs.gov/
retirement
for annual
updates
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Contributor's Employee can decide how much Employer can decide
Options to contribute at any time. whether to make
contributions
year-to-year.
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Minimum There is no requirement. Must be offered to all
Employee Can be made available to any employees who are at
Coverage employee. least 21 years old,
Requirements employed by the employer
for 3 of the last 5 years
and had compensation of
$600 for 2015 and
for 2016.
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Withdrawals, Withdrawals permitted Withdrawals permitted
Loans & anytime subject to federal anytime subject to
Payments income taxes; early federal income taxes;
withdrawals subject to an early withdrawals subject
additional tax (special to an additional tax.
rules apply to Roth IRAs). Participants cannot take
Participant loans are not loans from their
permitted. SEP-IRAs.
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Vesting Contributions are Contributions are
immediately 100% vested. immediately 100% vested.
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[Table Continued]
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IRA-BASED PLANS
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SIMPLE IRA Plan Profit Sharing
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Key Salary reduction plan with Permits employer to make
Advantage little administrative large contributions for
paperwork. employees.
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Employer Any employer with 100 or Any employer with one or
Eligibility fewer employees that does more employees.
not currently maintain
another retirement plan.
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Employer's May use IRS Form No model form to
Role 5304-SIMPLE or 5305-SIMPLE establish this plan. May
to set up the plan. No need advice from a
annual filing requirement financial institution or
for employer. Bank or employee benefit adviser.
financial institution Must file annual
handles most of the Form 5500.
paperwork.
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Contributors Employee salary reduction Annual employer
To The Plan contributions and employer contribution is
contributions. discretionary.
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Maximum Employee: $12,500 in 2015 Up to the lesser of 100%
Annual and in 2016. of compensation1 or
Contribution Participants age 50 or over $53,000 for 2015 and
(per can make additional for 2016.
participant) contributions up to $3,000 Employer can deduct
for 2015 and for amounts that do not
See irs.gov/ 2016. exceed 25% of aggregate
retirement compensation for all
for annual Employer: Either match participants.
updates employee contributions 100%
of first 3% of compensation
(can be reduced to as low
as 1% in any 2 out of 5
yrs.); or contribute 2% of
each eligible employee's
compensation2.
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Contributor's Employee can decide how Employer makes
Options much to contribute. contribution as set by
Employer must make matching plan terms.
contributions or contribute
2% of each employee's
compensation.
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Minimum Must be offered to all Generally, must be
Employee employees who have offered to all employees
Coverage compensation of at least at least 21 years old who
Requirements $5,000 in any prior 2 worked at least 1,000
years, and are reasonably hours in a previous year.
expected to earn at least
$5,000 in the current year.
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Withdrawals, Withdrawals permitted Withdrawals permitted
Loans & anytime subject to federal after a specified event
Payments income taxes; early occurs (retirement, plan
withdrawals subject to an termination, etc.)
additional tax. Participants subject to federal income
cannot take loans from their taxes. Plan may permit
SIMPLE IRAs. loans and hardship
withdrawals; early
withdrawals subject to an
additional tax.
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Vesting All contributions are May vest over time
immediately 100% vested. according to plan terms.
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[Table Continued]
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DEFINED CONTRIBUTION PLANS
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Automatic Enrollment
Safe Harbor 401(k) 401(k)
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Key Permits high level of salary Provides high level of
Advantage deferrals by employees participation and permits
without annual high level of salary
nondiscrimination testing. deferrals by employees.
Also safe harbor relief
for default investments.
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Employer Any employer with one or Any employer with one or
Eligibility more employees. more employees.
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Employer's No model form to establish No model form to
Role this plan. May need advice establish this plan. May
from a financial institution need advice from a
or employee benefit adviser. financial institution or
A minimum amount of employer employee benefit adviser.
contributions is required. May require annual
Must file annual Form 5500. nondiscrimination testing
to ensure that plan does
not discriminate in favor
of highly compensated
employees. Must file
annual Form 5500.
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Contributors Employee salary reduction Employee salary reduction
To The Plan contributions and employer contributions and may be
contributions. employer contributions.
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Maximum Employee: $18,000 in 2015 Employee: $18,000 in 2015
Annual and in 2016. and $1X,X00 in 2016.
Contribution Participants age 50 or over Participants age 50 or
(per can make additional over can make additional
participant) contributions up to $6,000 contributions up to
in 2015, and in $6,000 in 2015, and
See irs.gov/ 2016. in 2016.
retirement
for annual Employer/Employee Combined: Employer/Employee
updates Up to the lesser of 100% of Combined: Up to the
compensation1 or $53,000 for lesser of 100% of
2015 and for 2016. compensation1 or $53,000
Employer can deduct (1) for 2015 and for
amounts that do not exceed 2016. Employer can deduct
25% of aggregate (1) amounts that do not
compensation for all exceed 25% of aggregate
participants and (2) all compensation for all
salary reduction participants and (2) all
contributions. salary reduction
contributions.
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Contributor's Employee can decide how much Employees, unless they
Options to contribute based on a opt otherwise, must make
salary reduction agreement. salary reduction
The employer must make contributions specified
either specified matching by the employer. The
contributions or a 3% employer can make
contribution to all additional contributions,
participants. including matching
contributions as set by
plan terms.
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Minimum Generally, must be offered Generally, must be
Employee to all employees at least 21 offered to all employees
Coverage years old who worked at at least 21 years old who
Requirements least 1,000 hours in a worked at least 1,000
previous year. hours in a previous year.
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Withdrawals, Withdrawals permitted after Withdrawals permitted
Loans & a specified event occurs after a specified event
Payments (retirement, plan occurs (retirement, plan
termination, etc.) subject termination, etc.)
to federal income taxes. subject to federal income
Plan may permit loans and taxes. Plan may permit
hardship withdrawals; early loans and hardship
withdrawals subject to an withdrawals; early
additional tax. withdrawals subject to an
additional tax.
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Vesting Employee salary reduction Employee salary reduction
contributions and all safe contributions are
harbor employer immediately 100% vested.
contributions are Employer contributions
immediately 100% vested. may vest over time
Some employer contributions according to plan terms.
may vest over time according
to plan terms.
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[Table Continued]
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DEFINED CONTRIBUTION PLANS
------------------------------------------- DEFINED BENEFIT
Traditional 401(k) PLANS
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Key Permits high level of salary Provides a fixed,
Advantage deferrals by employees. pre-established benefit
for employees.
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Employer Any employer with one or Any employer with one or
Eligibility more employees. more employees.
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Employer's No model form to establish No model form to
Role this plan. May need advice establish this plan.
from a financial institution Advice from a financial
or employee benefit adviser. institution or employee
Requires annual benefit adviser would be
nondiscrimination testing to necessary. Must file
ensure that plan does not annual Form 5500. An
discriminate in favor of actuary must determine
highly compensated annual contributions.
employees. Must file annual
Form 5500.
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Contributors Employee salary reduction Primarily funded by
To The Plan contributions and may be employer.
employer contributions.
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Maximum Employee: $18,000 in 2015 Annually determined
Annual and in 2016. contribution.
Contribution Participants age 50 or over
(per can make additional
participant) contributions up to $6,000
in 2015, and in
See irs.gov/ 2016.
retirement
for annual Employer/Employee Combined:
updates Up to the lesser of 100% of
compensation1 or $53,000 for
2015 and for 2016.
Employer can deduct (1)
amounts that do not exceed
25% of aggregate
compensation for all
participants and (2) all
salary reduction
contributions.
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Contributor's Employee can decide how Employer generally
Options much to contribute based on required to make
a salary reduction contribution as set by
agreement. The employer can plan terms.
make additional
contributions, including
matching contributions as
set by plan terms.
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Minimum Generally, must be offered Generally, must be
Employee to all employees at least 21 offered to all employees
Coverage years old who worked at at least 21 years old who
Requirements least 1,000 hours in a worked at least 1,000
previous year. hours in a previous year.
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Withdrawals, Withdrawals permitted after Payment of benefits after
Loans & a specified event occurs a specified event occurs
Payments (retirement, plan (retirement, plan
termination, etc.) subject termination, etc.). Plan
to federal income taxes. may permit loans; early
Plan may permit loans and withdrawals subject to an
hardship withdrawals; early additional tax.
withdrawals subject to an
additional tax.
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Vesting Employee salary reduction May vest over time
contributions are according to plan terms.
immediately 100% vested.
Employer contributions may
vest over time according to
plan terms.
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1 Maximum compensation on which 2015 contributions
can be based is $265,000 ($2XX,000 for 2016).
2 Maximum compensation on which 2015 employer 2%
contributions can be based is $265,000 ($2XX,000 for 2016).
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Payroll Deduction IRAs
Even if an employer doesn't want to adopt a retirement plan, the employer can allow its employees to contribute to an IRA through payroll deductions, providing a simple and direct way for employees to save. In this type of arrangement, the employee always makes the decisions about whether, when, and how much to contribute to the IRA (up to $5,500 for 2015 and for 2016 and $6,500 for 2015 and for 2016 if age 50 or older, increasing thereafter).
Some individuals eligible to contribute to an IRA wait until the end of the year to set aside the money and then find that they don't have sufficient funds to do so. Payroll deductions allow employees to plan ahead and save smaller amounts each pay period. Payroll deduction contributions are tax-deductible by the employee, to the same extent as other IRA contributions.
Simplified Employee Pensions (SEPs)
A SEP plan allows employers to set up SEP IRAs for themselves and each of their employees. Employers generally must contribute a uniform percentage of pay for each employee, although they do not have to make contributions every year. Employer contributions are limited to the lesser of 25 percent of pay or $53,000 for 2015 and for 2016. (Note: the dollar amount is indexed for inflation and may increase.) Most employers, including those who are self-employed, can establish a SEP.
SEPs have low start-up and operating costs and can be established using a two-page form. And you can decide how much to put into a SEP each year -- offering you some flexibility when business conditions vary.
A SIMPLE IRA plan is a savings option for employers with 100 or fewer employees.
This plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. Under SIMPLE IRA plans, employees can set aside up to $12,500 in 2015 and in 2016 ($15,500 in 2015 and in 2016 if age 50 or older) by payroll deduction (subject to cost-of-living adjustment in later years). Employers must either match employee contributions dollar for dollar -- up to 3 percent of an employee's compensation -- or make a fixed contribution of 2 percent of compensation for all eligible employees, even if the employees choose not to contribute.
If your plan provides for it, you can choose to automatically enroll employees in SIMPLE IRA plans as long as the employees are allowed to choose not to have salary reduction contributions made to their SIMPLE IRAs or to have salary reduction contributions made in a different amount.
SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs (to hold contributions made under the SIMPLE IRA plan) are established for each employee. A financial institution can do much of the paperwork. Additionally, administrative costs are low.
You may have your employees set up their own SIMPLE IRAs at a financial institution of their choice or have all SIMPLE IRAs maintained at one financial institution you choose.
Employees can decide how and where the money will be invested, and keep their SIMPLE IRAs even when they change jobs.
Employer contributions to a profit sharing plan can be discretionary. Depending on the plan terms, there is often no set amount that an employer needs to contribute each year.
If you do make contributions, you will need to have a set formula for determining how the contributions are allocated among plan participants. The funds are accounted separately for each employee.
Profit sharing plans can vary greatly in their complexity. Many financial institutions offer prototype profit sharing plans that can reduce the administrative burden on individual employers.
401(k) plans have become a widely accepted retirement savings vehicle for small businesses. An estimated 53 million U.S. workers participate in 401(k) plans that have total assets of about $4 trillion.
With a 401(k) plan, employees can choose to defer a portion of their salary. So instead of receiving that amount in their paycheck today, the employees can contribute the amount into a 401(k) plan sponsored by their employer. These deferrals are accounted separately for each employee. Deferrals are made on a pretax basis but, if the plan allows, the employee can choose to make them on an after-tax (Roth) basis. Many 401(k) plans provide for employer matching or other contributions. The Federal Government and most state governments do not tax employer contributions and pretax deferrals (plus earnings) until distributed.
Like most profit sharing plans, 401(k) plans can vary significantly in their complexity. However, many financial institutions and other organizations offer prototype 401(k) plans, which can greatly lessen the administrative burden of establishing and maintaining these plans.
A safe harbor 401(k) plan is intended to encourage plan participation among rank-and-file employees and to ease the administrative burden by eliminating the tests ordinarily applied under a traditional 401(k) plan. This plan is ideal for businesses with highly compensated employees whose contributions would be limited in a traditional 401(k) plan.
A safe harbor 401(k) plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. In a safe harbor 401(k) plan, the mandatory employer contribution is always 100 percent vested.
Automatic Enrollment 401(k) Plans
Automatic enrollment 401(k) plans can increase plan participation among rank-and-file employees and make it more likely that the plan will pass the tests ordinarily required under a traditional 401(k) plan. Some automatic enrollment 401(k) plans are exempt from the testing. This type of plan is for employers who want a high level of participation, and who have highly compensated employees whose contributions might be limited under a traditional 401(k) plan.
Employees are automatically enrolled in the plan and contributions are deducted from their paychecks, unless they opt out of contributing after receiving notice from the plan. There are default employee contribution rates, which may rise incrementally over the first few years, although the employee can choose different amounts.
Some employers find that defined benefit plans offer business advantages. For instance, businesses can generally contribute (and therefore deduct) more each year than in defined contribution plans. In addition, employees often value the fixed benefit provided by this type of plan and can often receive a greater benefit at retirement than under any other type of retirement plan. However, defined benefit plans are often more complex and, likely, more expensive to establish and maintain than other types of plans.
The following jointly developed publications are available for small businesses on the DOL and IRS websites and through DOL's toll-free number listed below:
• 401(k) Plans for Small Businesses (Publication 4222)
• Automatic Enrollment 401(k) Plans for Small Businesses (Publication 4674)
• Payroll Deduction IRAs for Small Businesses (Publication 4587)
• Profit Sharing Plans for Small Businesses (Publication 4806)
• SEP Retirement Plans for Small Businesses (Publication 4333)
• SIMPLE IRA Plans for Small Businesses (Publication 4334)
For business owners with a plan:
• Adding Automatic Enrollment to Your 401(k) Plan (Publication 4721)
• Retirement Plan Correction Programs (Publication 4224)
DOL website: dol.gov
Publications request number: 866-444-3272
IRS website: irs.gov/retirement
Also available from the U.S. Department of Labor:
DOL sponsors an interactive website -- the Small Business Retirement Savings Advisor, available at /taxbasehttp://webapps.dol.gov/elaws/ebsaplan.htm -- that encourages small business owners to choose the appropriate retirement plan for their business and provides resources on maintaining plans.
Publications for plan officials:
• Meeting Your Fiduciary Responsibilities
• Understanding Retirement Plan Fees and Expenses
• Selecting an Auditor for Your Employee Benefit Plan
• Selecting and Monitoring Pension Consultants -- Tips for Plan Fiduciaries
• Tips for Selecting and Monitoring Service Providers for Your Employee Benefit Plan
Also available from the Internal Revenue Service:
• Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), (Publication 560)
• Contributions to Individual Retirement Arrangements (IRAs), (Publication 590-A)
• Distributions from Individual Retirement Arrangements (IRAs), (Publication 590-B)
• Designated Roth Accounts Under 401(k), 403(b), or Governmental 457(b) Plans, (