Recent legislation provides some new choices for companies that want to adopt employee savings programs. Those considering new retirement programs or changes in existing ones must understand the different plan designs available. Companies also need to select from among the array of retirement plan providers, including insurance companies, mutual funds, banks and brokerage firms. Although the program features may differ among providers, overall plan benefits have improved in the past 10 years because of increased competition and software sophistication; administration costs also have decreased. This article describes the factors a company should use to select the right plan design and program provider, thereby helping to keep it focused on advancing sales, not on problems of declining plan enrollment or administrative headaches.
Since the early 1980s, only two retirement plans--the 401(k) and the salary reduction/simplified employee pension (SAR/SEP)--allowed for employee deferrals. As 401(k) administration costs dropped and SAR/SEP design restrictions created headaches for small business owners, 401(k) plans became more popular. However, employers still remained frustrated with the strict discrimination rules limiting the extent to which highly compensated employees (HCEs) make 401(k) contributions: Highly paid executives benefit only when non-HCEs participate. Moreover, employees are unhappy when employers do not match a portion of their deferrals. The answer? The Small Business job Protection Act of 1996 introduced the Savings Incentive Match Plans for Employees (called SIMPLE plans)--an individual retirement account and a 401(k). The SIMPLE IRA replaced the SAR/SEP. Are these plans really simple, and do they address the concerns outlined above?
THE SIMPLE PLANS
Generally speaking, the introduction of the SIMPLE plans means employers no longer have to perform discrimination tests when they meet certain predetermined conditions. The most restrictive requires the employer to make a matching contribution of up to 3% of employee compensation or a 2% of compensation nonelective contribution for all eligible employees. While the matching contribution applies only to those employees who participate in the plan, the nonelective contribution is similar to a pension contribution and is made for all eligible employees regardless of participation.
Although the SIMPLE IRA and SIMPLE 401(k) plans are similar to each other, some differences are worth noting. The SIMPLE 401(k) permits loans; the SIMPLE IRA does not. Aside from this disadvantage, however, the SIMPLE IRA generally provides more flexibility for the small business owner, including
* Few or no administrative costs.
* Fewer administrative responsibilities.
* Higher contribution limits. Even though the employee contribution limit is the same with both plans ($6,000), maximum contributions differ. The maximum to a SIMPLE IRA is $12,000; to a SIMPLE 401(k), it is $10,800. Why the difference? While plan contributions are based on a $160,000 compensation limit, the Internal Revenue Service left undefined the compensation limit in one area--the employer match in the SIMPLE IRA. If, for example, a company opts for a 3% match, an employee who earns $200,000 need contribute only 3% to reach the $6,000 maximum deferral. In determining the required company match, the SIMPLE 401(k) is limited to $160,000; with the SIMPLE IRA, there is no limit. Therefore, the match required with the SIMPLE 401(k) is $160,000 X 3%, or $4,800. The match required with the SIMPLE IRA is $1,200 more: $200,000 X 3%, or $6,000.
* Withdrawal flexibility. Employees can make withdrawals from a SIMPLE IRA at any time (the Internal Revenue Service imposes a 25% penalty in the first two years). Employees can make withdrawals from a SIMPLE 401(k) only for death, disability, hardship or separation from service. Penalties apply to all distributions made before age 59 1/2.
* Investment flexibility. Generally speaking, contributions to a SIMPLE IRA can be made to any financial institution the employee chooses. Contributions to a SIMPLE 401(k) must be made to the preselected investment options determined by the company.
* Stronger employer fiduciary protection. With the SIMPLE IRA, much of the responsibility rests with the financial institution. With the SIMPLE 401(k), the plan sponsor or the employer has more responsibility.
* More flexibility with matched contributions. The SIMPLE IRA allows for reduced matching contributions--1% of compensation instead of the regular 30%--in no more than two out of any five years.
For the reasons outlined above, the SIMPLE IRA may be a more attractive option for many companies. Therefore, the decision to adopt a company savings program may come down to a...