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Establishing an IRA plan for your employees

Written by: Gabrielle Smith
May 17, 2021 at 8:19 AM

When it comes to recruiting and retaining employees, your benefits package is a top deciding factor for job prospects when they’re looking for a new employer. Research for the 2021 Robert Half Salary Guides reveals that a retirement savings plan is in the top five most common benefits offered by employers in the U.S., so it’s undoubtedly worth including.

One way to invest in your employees’ retirement is by offering an individual retirement account (IRA), with contributions from either your organization, your employees, or both.

There are three types of IRAs that employers can use to encourage workers to save for retirement:

  • A payroll deduction IRA
  • A simplified employee pension
  • A savings incentive match plan for employees

Want quick employee retention tips? Our guide has 11 simple strategies

Payroll deduction IRAs

First, let’s start off with payroll deduction IRAs. These are a good choice for employers who want to help employees save for retirement, but may not have the budget to contribute to the account.

Like the name suggests, payroll deduction IRA contributions are made solely by the employee as a deduction from their paycheck. Each employee gets to decide how much of each paycheck they would like to contribute to their IRA, so long as they don’t exceed the contribution limits.

For 2021, the maximum contribution limit is $6,000 (or $7,000 for investors who are at least 50 years old). Payroll deduction IRAs feature low administrative costs, and there’s no minimum number of employee participation requirements or mandatory annual filing with the government.

Even if only some of your employees are interested in making IRA contributions through payroll, you must make the option available to everyone.

If you choose to set up a payroll deduction IRA, you have two options:

  • Traditional IRA
  • Roth IRA

Traditional IRA

A traditional IRA is a retirement savings plan that provides an upfront tax break. Contributions to a traditional IRA are made before the deduction of taxes, so the earnings on the amount in the IRA aren’t taxed until the money is taken out.

If you’re at least 59 and a half years old, you can withdraw money from your traditional IRA without penalties. However, generally speaking, anyone younger than 59 and a half is subject to a 10% early withdrawal penalty if they take any funds out of their account.

Roth IRA

A Roth IRA differs from the traditional IRA in that its contributions are made with money that has already been taxed. Also, qualified distributions after retirement are free of income tax.

One of the best benefits of a Roth IRA is that no taxes are paid on capital gains or dividends on the investments. That means a Roth IRA’s distributions, including its earnings, are not included as income.

For many individuals, there’s a good possibility that they will be in a higher income tax bracket when retiring. If that’s the 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.

Another perk of Roth IRAs is that there are more circumstances in which contributions can be taken out 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
  • The investor is purchasing their first home
  • The investor is disabled or deceased
  • The account is at least five years old

For distributions that don’t qualify, earnings are taxable and subject to the same 10% early withdrawal penalty as the traditional IRA.

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

If you choose to set up a payroll deduction IRA plan, you first must inform your employees that they have the ability to establish an IRA outside of their employment and that you’re not providing any additional benefit other than the convenience of immediate payroll deductions.

Next, you’ll simply establish a payroll deduction IRA program with a bank, mutual fund, or insurance company. Each employee may choose whether they want to establish a traditional IRA or a Roth IRA and will then authorize the payroll deductions.

Finally, you will withhold deductions from participating employees’ paychecks and immediately send those funds to the financial institution. For simplicity, you may choose to limit employees to just one IRA provider.

Simplified employee pension plan

The next option you have for a retirement savings account for your employees is a simplified employee pension (SEP). A SEP plan is an easy way for employers to make a direct contribution to their employees’ retirement.

Unlike the payroll deduction IRA, only employers may contribute to a SEP IRA. However, it comes with a much higher annual contribution limit—up to 25% of an employee’s salary or $58,000 in 2021 (whichever is lower). Employer contributions must be equal for all employees.

With a SEP IRA, the employer 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. All contributions made to SEP IRAs are 100% vested to the employee.

Keep in mind that if you choose to offer a SEP IRA, you aren’t allowed to offer any other retirement plans along with it (except for a second SEP IRA).

How to establish a simplified employee pension plan

With a SEP plan, an IRA is set up for each employee, and the employer will contribute directly to each SEP IRA. Employers are allowed to adjust the amount they contribute throughout the year, which makes it ideal for employers who experience highs and lows in revenue during different seasons.

To get set up, all you have to do is fill out the 5035-SEP form and follow all of the instructions. Administrative costs for these plans are minimal and require no annual filing.

A savings incentive match plan for employees

A savings incentive match plan for employees (SIMPLE) IRA is a plan where both the employer and the employee can make contributions.

Employees may make contributions via salary deductions, and the employer 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 employers that had no more than 100 employees during the previous calendar year. In 2021, employees can defer up to $13,500 of their annual income and $3,000 in catch-up contributions if they are at least 50 years old.

How to establish a SIMPLE IRA

To establish a SIMPLE IRA, you must first adopt a plan document by signing Form 5304-SIMPLE or Form 5305-SIMPLE. Form 5305 should be used if you require all contributions to be sent to a specified financial institution. Form 5304 is used when each employee wants the option to choose the financial institution they would like to use.

Next, you 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, you’ll 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.

With a SIMPLE IRA plan, you may make a matching contribution up to 3% of the employee’s pay. If an employee doesn’t want to participate, you must make a 2% non-elective contribution. If you choose to offer a SIMPLE IRA plan, you may not offer any other retirement plan to employees.

In a SIMPLE IRA plan, your matching contributions vest immediately with the employee and follow them whenever they leave the organization. For the first three years of the plan, organizations may be eligible to receive a tax credit of 50% for the plan’s administrative costs (a maximum of $500 per year on the amount that can be credited).

What else should my employee benefits package include?

While a retirement savings plan is an important benefit to offer, the 2021 Robert Half Salary Guides found that it’s not the most popular. Out of 500 HR managers surveyed in the U.S., health insurance consistently outranked retirement savings plans as the most common employee benefit—in fact, it’s ranked at the very top.

Group health insurance is the traditional choice, but for small employers looking to offer a formal health benefit on a budget, there’s a more affordable and flexible alternative: health reimbursement arrangements (HRAs).

Through an HRA, employers can give employees tax-free money to purchase individual insurance and medical expenses on their own that meet their personal healthcare needs. You’re in complete control of the budget, while your employees get to control exactly how they use their allowance.

PeopleKeep offers three HRAs that cater to any company size or budget:

Take our quiz to find out which HRA is best for your organization

Conclusion

Retirement savings accounts are an excellent way for employers to recruit and retain employees—especially for small employers who may not be able to afford the higher salaries of larger organizations. Whether you want a plan you personally contribute to as an employer, a plan that’s funded by your employees, or one that includes contributions from both you and your employees, there’s an option that will work for you.

This article was originally published on August 3, 2016. It was last updated on May 17, 2021.

Topics: Employee Retention, Retirement

Additional Resources

Learn how to help your employees get their health costs reimbursed.
Get our guide on how to offer health benefits with a small budget.

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