Business Retirement Plans - Tax Advantages

Though it may sound expensive at first, supplying a retirement plan for your employees actually has many benefits. Retirement plans allow both you and your employees to invest for the future, making it easier to attract and retain employees, and can provide certain tax advantages to the company and to its employees.  For example, employer contributions to plans are tax deductible, and assets in the plans grow by compounding interest tax-free.

Choosing a retirement plan for your company is a process that usually requires the input of a tax professional, or of a financial institution offering retirement plans. Here is some basic information on the most common types of plans.

401(K)
A 401(k), the most common type of plan, is usually sponsored by an employer, such as corporation or non-profit organization. The sponsor creates and designs the plan, and names a fiduciary. Employees choose a percentage of their wages to be placed in the retirement plan, and can defer income taxes on these savings and earnings until they withdraw money from the plan. Employees can also rollover their 401(k) plans to an IRA or other retirement plan, such when they transfer jobs.

Employers can choose to match part or all of their employees’ contributions, or they can offer a profit sharing contribution. Employees can also choose from a number of investment options like mutual funds, stocks, and bonds. Furthermore, 401(k)s are protected against employer bankruptcy.

Roth contributions are also an option, where employees pay taxes on contributions but can ultimately make tax-free withdrawals.

403(B)
A 403(b) is a retirement plan that’s available to public education organizations, cooperative hospital service organizations, self employed ministers, and certain non-profit organizations. Like a 401(k), employees defer some of their salary into the plan before income tax is paid, and the fund is allowed to grow tax-free until the employee starts withdrawing income from it. Also as in 401(k)s, 403(b) plans may include Roth contributions, where the contribution is taxed but once requirements are met, withdrawals are tax-free. There is no bankruptcy protection.

IRC 457
An IRC 457 is for governmental and certain non-governmental employers. As in a 401(k), the employer provides the plan, and employees pay into it without being taxed on their contributions. Unlike 401(k) and 403 (b) plans, 457 plans allow independent contractors to participate, and there’s no 10% penalty for withdrawal before the plan holder turns 59 1/2 (ordinary income taxation applies). A 457 plan does not allow designated Roth contributions.

IRA
IRA stands for “Individual Retirement Arrangement”; it can be either employer provided or self provided. In all cases, IRAs can only be funded by cash or cash equivalents. Rollovers and transfers between IRAs and other retirement accounts can include any type of asset, though. Borrowing money from an IRA disqualifies the account from special tax treatment.

• A Roth IRA is one where contributions are taxed, but any transactions within the IRA are not taxed. Withdrawals are usually tax free.
• A Traditional IRA has tax-deductible contributions, and transactions within the IRA have no tax impact. Withdrawals at retirement are taxed as income.
• A SEP IRA allows an employer such as a small business or even a self employed individual to make contributions directly into an IRA set up in the employee’s name, rather than into a pension account in the company’s name.
• A Simple IRA lets employers and employees make contributions with lower contribution limits and simpler administration. This makes the simple IRA less expensive, but it also means it’s not necessarily treated as an IRA.
• A Self directed IRA allows the account holder to make investments for the retirement plan.

Laws on this topic may vary from state to state. This content is not meant to provide you with complete information and it is not intended to be legal or tax advice. It is recommended that you consult with your own attorney, accountant or other advisor regarding your specific situation.