Offering a retirement plan to your employees can be mutually beneficial in several ways. Besides improving the well-being of your workers and positively impacting their future, it can be used as a recruiting tool, serve as a motivator for increased productivity and decrease turnover. Additionally, it can often give your business some considerable tax advantages. Which type of retirement plan should you offer?
Defined Contribution Plan
A defined contribution plan is on the Investopedia website as “a retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee.” There are several types of plans that fit under this umbrella including 401(k), 403(b), SIMPLE, etc. When it comes to how much money an employee can pull out of a defined contribution plan, it’s contingent upon how much you and your employee put in and the interest rate.
- You and your employees have more control over what you contribute
- You can easily calculate your obligations each year
- You could potentially incur fines if you’re not compliant with the IRS, HIPAA, ERISA, etc.
Defined Benefit Plan
A defined benefit plan is defined on the Investopedia website as “an employer-sponsored retirement plan where employee benefits are sorted out based on a formula using factors such as salary history and duration of employment.” As an employer, you’ll usually make most of the contributions — and unlike a defined contribution plan, employees receive a fixed amount of money once they retire. Choosing this plan tends to work well for many smaller businesses because there are no employee number requirements.
- You can often get bigger tax deductions with a defined benefit plan than you could with a defined contribution plan
- Significant benefits can accumulate within a relatively short period of time
- Employees can better predict the benefits they’ll receive
- This tends to be a costly plan to establish
- It’s complicated from an administrative standpoint
- You will have to pay an excise tax if either minimum contributions are not made or excess contributions are made
Qualified Retirement Plan
Unlike the previous two types of plans, a Qualified Retirement Plan is also defined on the Investopedia website as “falling outside of ERISA guidelines” and is not eligible for tax-deferral benefits. In turn, they tend to be very flexible and can be customized to the specific needs of individual employees. These aren’t usually used for lower-ranking employees, but instead are designed for those in executive positions. As a result, a qualified retirement plan isn’t geared toward the masses, but can be ideal in certain cases.
- There is a lot of leeway, and it can be tailored to reach an employee’s exact objectives
- You can minimize your administrative and funding costs
- There can be major long-term tax advantages
- It isn’t practical unless you have high-ranking executive employees
- You can’t capitalize on deductions until an employee actually retires
- It comes with greater liability than other plans
There’s no doubt that offering a retirement plan is a great choice for many employers and can be a contributing factor to the long-term success of your business. Understanding the key differences between these common plans allows you to choose the best one that meets the needs of both your company and employees.