Business owners hold the key to their employees' well-being, and a critical part of that involves understanding the basics of employee retirement plans. Establishing an effective retirement plan can help prepare employees for financial independence and attract and retain the best talent in the industry.
Understanding retirement savings plans
A retirement plan refers to a financial arrangement designed to replace employment income upon retirement. Financial professionals, insurance companies, the government, and other institutions, such as employer associations or trade unions, can set up these plans. Retirement plans come in various formats, including defined benefit, defined contribution, and hybrid plans.
Defined Benefit plans – These plans provide a retiree with a fixed, pre-established benefit for life, based on factors such as age, earnings, and years of service.
Defined Contribution plans – In these plans, both the employer and employee contribute to the employee's retirement fund. The most common example is a 401(k) plan. The contribution is often a percentage of the employee's salary.
The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses.
Profit-sharing plans – These plans allow employers to make discretionary contributions to employees. The contribution amount varies based on the company's profits.
Importance of employee retirement savings plans
Employee retirement savings plans provide several advantages:
Employee attraction and retention – Offering a retirement plan can make the company more appealing to job seekers. It also encourages current employees to stay, reducing turnover and associated costs.
Tax advantages – Contributions to retirement plans are generally tax-deductible to the business, and any earnings on the contributions grow tax-deferred until withdrawal by the employee.
Help employees save for retirement – Retirement savings plans provide an easy and automatic way for employees to save and invest for the future.
Key features of employee retirement plans
Several critical features define an effective employee retirement plan:
Vesting – Refers to the ownership of the contributions to the retirement plan. While an employee's contributions are always immediately vested, employer contributions may take several years to vest fully.
Contributions – These can be voluntary or mandatory and can be made by employees, the employer, or both.
Investment options – Retirement plans often offer a variety of investment options, usually mutual funds, for employees to choose from.
Distribution rules – These rules dictate when and how an employee can withdraw funds from their retirement account. Early withdrawals may result in penalties.
Considerations for selecting a retirement plan
Selecting the appropriate retirement plan involves working with a financial professional to select a plan by considering several factors:
Business size – The selected plan should align with the business's size and structure. For example, larger businesses may benefit from 401(k) plans, while smaller businesses may prefer simpler options such as SEP IRAs.
Employee demographics – Consider employees' needs and preferences. Younger employees may prefer flexible plans and investment strategies, while older employees might lean toward more structured investment options.
Cost and complexity – More complex plans, such as 401(k)s, may offer greater benefits but come with higher administrative costs.
Implementing a retirement plan
Once a plan is chosen, the next step is implementation, which involves:
Choosing a Plan Administrator – A plan administrator can be either an external third party or an internal human resources employee. They'll handle day-to-day management and ensure legal compliance.
Creating a plan document – This document outlines the plan's operations and management.
Establishing a Trust Fund – All retirement plan assets must be held in a trust to ensure they're used only for participants' benefit. A financial institution can hold plan funds on behalf of a retirement plan and participants.
Developing a recordkeeping system – Accurate recordkeeping to track contributions, earnings and losses, distributions, and plan investments is mandatory for IRS reporting.
Fiduciary duties
As an employer offering a retirement plan, there are fiduciary responsibilities, such as:
Acting prudently and diligently
Diversifying investments
Following the plan's terms
Avoiding conflicts of interest
Communicating the retirement plan to employees
Once the retirement savings plan is in place, provide employees with comprehensive information about the plan's benefits, enrollment, and how contributions are managed.
Offering a retirement plan is a significant step toward positioning the business as a desirable place to work. It's a worthy investment that can yield significant dividends – by investing in your employees' futures, you're also investing in your business's future.
Important Disclosures:
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
LPL Tracking #1106558
Sources:
https://www.dol.gov/agencies/ebsa/employers-and-advisers/small-business-owners/understanding-your-responsibilities#
https://www.irs.gov/retirement-plans/irc-401k-plans-establishing-a-401k-plan
https://www.irs.gov/retirement-plans/retirement-plan-fiduciary-responsibilities#
https://www.pew.org/en/research-and-analysis/issue-briefs/2024/07/small-employers-economics-of-offering-retirement-savings-plans#