<img src="//bat.bing.com/action/0?ti=5067266&amp;Ver=2" height="0" width="0" style="display:none; visibility: hidden;">
GET STARTED

Small Business Employee Benefits and HR Blog

Establishing an IRA Plan for Your Employees

August 3, 2016
XL_office_desk_work_hero

Helping employees plan for retirement is one way that businesses can remain competitive in the retention and recruitment of employees. Offering an individual retirement account (IRA), with contributions from either the company or the company and the employee, can be a great way to do this. Establishing an IRA Plan for your EmployeesThere are three primary types of vehicles that companies can use to encourage workers to save for retirement: A payroll deduction IRA, a Simplified Employee Pension (SEP), and a Savings Incentive Match Plan for Employees Individual Retirement Account, or SIMPLE IRA.

Payroll Deduction IRAs

Payroll deduction IRAs are a good choice for companies who want to help employees save for retirement but don’t wish to contribute to the account. A company who establishes payroll deduction IRAs must make them available to all employees, who determine how much of each paycheck they would like to direct to their IRA. In 2016, the contribution limit is $5,500 or $6,500 for investors who are 50 years old or over. Payroll deduction IRAs feature low administrative costs, and there’s no minimum number of employee requirement or mandatory annual filing with the government.

Companies may not contribute to Roth or Traditional IRAs.

Traditional IRAs

There are two types of payroll deduction IRAs: A Roth IRA and a Traditional IRA, which is a retirement savings plan that provides certain tax advantages, such as an upfront tax break. A contribution to a Traditional IRA is made prior to the deduction of taxes, and the earnings on the amount in the IRA are not taxed until distributed. The tax-deductible portion of the contribution is not taxed until it is withdrawn. Distributions may be taken after age 59 1/2 without penalties. Prior to that time—aside from a few exceptions—they are subject to a 10 percent early withdrawal penalty.

Roth IRAs

A Roth IRA differs in that its contributions are made with money that has already been taxed. Also, qualified distributions after retirement are income tax-free. One of the best benefits of a Roth IRA is that no taxes are paid on capital gains or dividends on the investments. A Roth IRA’s distributions, including its earnings, are not included in income. For many individuals, there is a decent possibility that they will be in a higher income tax bracket when retiring. In such a case, even though the upfront tax break will be lost, a Roth IRA would be preferable over a Traditional IRA because higher taxes may be avoided in the future.

Distributions for a Roth IRA up to the amount that has been contributed can be taken at any time without having to pay taxes or a penalty. Certain qualified distributions are free from penalties and taxes if the investor is at least 59 1/2 years old, is purchasing her first home, is disabled or deceased, or if the account was created at least five years prior to the distribution. For distributions that do not qualify, earnings are taxable and subject to a 10 percent early withdrawal penalty.

Earnings for both Traditional and Roth IRAs that stay in the account remain untaxed. Both types of IRAs may be established at banks, brokerage firms, and insurance companies.

How to Establish a Payroll Deduction IRA Plan

Companies must inform employees that they have the ability to establish an IRA outside of their employment and that the company is not providing any additional benefit other than the convenience of immediate payroll deductions.

To set up an IRA, the company will establish a payroll deduction IRA program with a bank, mutual fund, or insurance company. Each employee may choose whether he or she wants to establish a Traditional IRA or a Roth IRA and will authorize payroll deductions. The company will withhold deductions from participating employees’ paychecks and immediately send those funds to the financial institution. For simplicity, the company may choose to limit IRA providers to just one.

SEP IRAs

A SEP plan is an easy way for companies to contribute to their own retirement and that of their employees. Only companies may contribute to a SEP IRA, which features a high annual contribution limit—up to the lesser of 25 percent of an employee’s salary or $53,000 in 2016. With a SEP IRA, the company receives a tax deduction for contributions made; the employees receiving those contributions are not taxed on them, but they will eventually be taxed at their income tax rate during distribution.

How to Establish a SEP IRA

An IRA is set up for each employee, and the company will contribute directly to each SEP IRA. These plans work well with companies whose businesses experience highs and lows throughout the year because the company may adjust the amount of the contribution.

For SEP plans, the size of a company does not matter. A company needs only to fill out the 5035-SEP form and follow all of the instructions. Administrative costs for these plans are minimal.

SEP plansrequire no annual filing, and all contributions made to SEP IRAs are 100 percent vested to the employee. Company contributions must be equal for all employees, and the maximum contribution amount is up to 25 percent of each employee’s salary. If a company offers a SEP IRA, it cannot offer any other retirement plan (except for a second SEP IRA).

SIMPLE IRAs

A SIMPLE IRA is a plan in which employees may make contributions via salary deductions, and the company must either contribute a matching or a non-elective amount. All contributions are sent directly to each employee’s SIMPLE IRA. Similar to a Traditional IRA, a SIMPLE IRA defers payment of income tax on any amounts contributed and earnings until distribution. Employee contributions to a SIMPLE IRA are not tax deductible.

SIMPLE IRA plans may only be established by a company that had no greater than 100 employees during the previous calendar year. In 2016, employees can defer up to $12,500 of income and $3,000 in catch-up contributions if they are age 50 or over.

How to Establish a SIMPLE IRA

To establish a SIMPLE IRA, a company must first adopt a plan document by signing Form 5304-SIMPLE or Form 5305-SIMPLE. Form 5305 should be used if the company requires all contributions to be sent to a specified financial institution. Form 5304 is used when each employee may choose which financial institution to use. Next, the company must give each eligible employee certain information about the SIMPLE IRA plan and the institution where employee contributions will be made prior to the employee election period, which is usually 60 days before January 1. Finally, the company must set up a SIMPLE IRA for each eligible employee via Form 5305-S (for a trust account) or Form 5305-SA (for a custodial account). These can be established at banks or insurance companies.

A company may make a matching contribution up to 3 percent of the employee’s pay. If an employee does not wish to participate, the company must make a 2 percent non-elective contribution. A company that offers a SIMPLE IRA plan may not offer any other retirement plan to employees.

In a SIMPLE IRA plan, a company’s matching contributions vest immediately with the employee and follow him whenever he leaves employment. For the first three years of the plan, companies may be eligible to receive a tax credit of 50 percent for plan’s administrative costs (a maximum of $500 per year on the amount that can be credited).

Conclusion

Companies can retain valuable employees by helping them save for their future. Offering employee-owned benefits such as HSAs, and a payroll deduction IRA, SEP IRA, or SIMPLE IRA plan is a terrific way to recruit new employees.

Are HRAs a good fit for your company?
Learn how to implement an HRA for your small business
GET THE EBOOK
meeting_wide-1 CTA_purp_R

Topics :