With the full implementation of the NJ Secure Choice Savings program not far away, it’s good to know your options when choosing a retirement plan for your employees.
While any plan will help your employees better prepare for their future, you’ll have to pick between different plan options. There are variations on the rules and restrictions from plan to plan, it’s not a one-size-fits-all type of thing.
Knowing about the differences between them and how your employees will use them is certain to save you many headaches and lots of time. Being able to answer employees’ questions about their retirement program will reassure them their money is being safely and logically invested.
Besides all the mathematical explanations of how much, for how long, for what cost, etc… It also shows you as an employer that goes beyond simply writing checks in exchange for employees’ labor. This is a huge deal, and something that employees appreciate and consider when they’re deciding to leave or stay in a position.
As an added perk, you’ll be able to entice the best talent to come work for you instead of your competition. Retirement saving is a stressful thing to get involved with, and working for a company that comprehensively explains their plan is a huge plus for those in the job market.
All these factors are at the heart of why New Jersey has followed Illinois, California, and several other states in establishing laws that require certain employers to offer some retirement savings program to their employees.
It’s debatable whether or not this is something that states should be making laws on, but I’m not here to get into that. The law is the law and it’s in your interest to avoid running afoul of it.
The details surrounding the NJ state plan remain to be seen, but I’m here to give you an overview of the programs you can pick through on the private market. Retirement planning isn’t too tough when it’s all laid out at once.
If this is all news to you, Click the link at the very beginning of this article. It details everything you need to know about New Jersey’s program. If this topic seemed out of left field before reading it, it won’t afterwards
Types of Retirement Plans
Defined benefit plans outline a specific dollar amount or formula used to calculate an amount, that determines how much the retiree is entitled to at each distribution (usually monthly). This type of plan has largely disappeared at all but the highest levels of private industry, and is usually seen in the public sector (police, public works, utilities).
Widely popular in the post war economic boom, nowadays these plans just post too much of a risk that future growth will be hampered by heavy pension responsibilities. Very few businesses are offering defined benefit plans these days.
That said, they are not completely unheard of, and are often a great choice for business owners planning for their own retirement. This will all be discussed in a future article on the topic of retirement planning for owners.
Defined contribution plans have become the standard for modern retirement investing. These plans are established to take a regular contribution from the employee, employer, or both. Those contributions are given to an investment management company and invested on behalf of the employee.
There are usually tax benefits and risks associated with the money directed to retirement savings. Roughly said, the money can be withdrawn, taxfree, past 59 ½ years of age. Conversely, hefty penalties are doled out for withdrawals earlier than this.
There are fees for this service, and this is one of the aspects that should be considered when choosing a plan and a financial management company for your employees’ investments. The more involved or aggressive your financial advisor is in managing your fund, the higher fees you can expect to pay.
You’ll see a range in fees from 0.1% to 2.0%. Around 1.0% of the assets managed is the average cost for money management with personalized financial advising. If you’re fine without the counsel, you can find a reputable money manager online that will simply manage the money for around 0.25% – 0.3%.
The fee schedule also depends on how many employees you have. Businesses with more employees pay less to have the money managed on average.
It’s up to you to decide the level of access you want to those making decisions about your employees’ savings. For some, regular phone calls and counsel on the next move is something you couldn’t imagine going without. For others, emailed monthly statements detailing the accounts’ value is more than enough involvement.
This is where it’s beneficial so many people are confused about the same investing topics. Financial advisors have gotten pretty good at answering the questions we have for them, as all their clients have the same ones.
Don’t be nervous about asking questions, even if you’re not sure of the question you’re trying to ask! A good advisor will probably know how to phrase it right and get the answer you’re looking for.
Things to Consider with Retirement Plans.
Before getting into the details of each plan, think broader than the numbers. Choosing a retirement plan is picking a strategy for the biggest investment most people ever make. It’s a huge decision, but it’s not a hard decision if you know what to think about going into it.
Consider who works for you. How old are they? How long do they usually stay working for you? How much do they earn? Different people want different things, so consider who you’re helping save money. An ice cream shop on the boardwalk should probably not offer the same plan as a dental practice.
Why exactly? The dental practice has highly skilled employees that work with them for longer periods. They’re older, they usually have families, and want more involvement in their retirement planning. It would make sense to provide a plan that focuses on a long-term strategy, you expect some of these people to be with you for years to come.
The ice cream shop is likely staffed by college and high school students who won’t become long term employees. They’re far less likely to want an active role in planning for retirement, or even choose to save at all! I would focus on a plan that is easily transferred to their next place of employment and not bother with any sort of detailed investment services for them.
Your Choice of Plans
The 401(k) is the most common type of retirement plan offered by employers.
How does it work? Deductions are taken from each paycheck and automatically deposited in a specific investment plan they or you have chosen. The employees pay a fee for the cost of management.
Employers are able to offer contributions but are not required to. It depends on the level of benefits each employer is trying to offer to their employees.
This is a more managed plan and would limit your employees ability to make decisions. An investment strategy is laid out, followed, and occasionally altered. Your investment manager will send updates on why they’re making these decisions as time goes on. Because of the hands on management, there are higher fees associated with 401(k)s.
This makes it great for people that want to casually save without spending too much time doing research on it.
Each employee can contribute up to $19,500 annually, deductible from their taxes that year. They then pay the taxes upon distribution in their retirement. There are tax penalties for withdrawals earlier before the age of 59 ½.
When an employee leaves a job, it’s usually possible for them to do nothing and the 401(k) will continue to invest the money that has been contributed to the account.
Employees can also choose to roll it over into a new employer’s 401(k) plan,
If you are a tax-exempt organization as determined by the IRS, you can offer your employees a 403(b). This is essentially a 401(k) for non-profits.
An IRA is a personalized investment tool for each of your employees. It allows them more control over their investments than they would have in a 401(k), and lower management fees. Unlike a 401(k) where employees are able to select from particular investment packages like items on a menu, IRAs allow for their holders to choose whatever type of strategy they’d like.
This usually appeals to older and more established people who are cautious about their investments. As people grow and develop more substantial savings, they’re more interested in knowing exactly how it’s being protected and by what means.
They are also more easily transferred from one institution to the next. While the employer establishes the means for their employees to open an IRA, they have a very limited role with the account past that. With an IRA, employers facilitate savings, not aid in it.
IRAs can provide the control and security that many people want when it comes to retirement planning.
Like a 401(k), an IRA allows for tax free contributions to the account with the taxes assessed upon disbursement. Unlike a 401(k), there is a $6,000 limit for annual contributions. Those over the age of 50 are permitted $7,000 in contributions annually
If I had to put it simply, IRAs are for people who want to know what’s happening, 401(k)s are for people who are glad they don’t.
A Roth IRA functions the same as an IRA with the exception of when contributors pay the tax. Roth IRAs tax the contributions when they are given, but disburse funds tax free in retirement.
This is ideal for people who want to pay what’s due up front and not think about it later. There is the logic that your contributions will grow to the point that they are taxed at a higher rate when distributed. Money can be saved by paying a lesser tax up front and being glad you did down the road.
A SEP (Simplified Employee Pension) IRA has a few notable rules that make it different from an IRA.
Only the employer contributes to SEP IRAs. Employees do not contribute to SEP IRAs. This is something an employer would offer to distinguish themselves from other employers, as it is a generous offer.
The plus sides are that the costs associated with establishing and managing it are notably lower. The simplified nature and low level of involvement required are reasons why business owners would offer such a plan.
The amount that can be contributed is also much higher, 25% of income or $58,000. The same taxation rules apply as do with regular IRAs: Tax free deposits, taxed withdrawals, penalties for withdrawals before 59 ½.
One of the specific requirements to set up a SEP IRA is that an employee must have worked for you for 3 of the last 5 years. This could be a hurdle to setting up a SEP IRA if you want all your employees to be eligible for the same plan.
Finally, the employee is responsible for handling all the taxes associated with their account. This could be more or less attractive depending on who you’re offering it to. Some might not be interested in paying extra fees and be happy to handle their taxes personally. Others might be disappointed to learn they have to handle another chore.
Simple IRA (for smaller businesses)
Small business owners, those with less than 100 employees, will probably be interested in the Simple IRA plan. This plan allows business owners to choose to provide a matching contribution up to 3%, or a flat 2% regardless of employee contribution. It also has a larger annual deposit limit of $13,500.
The same rules of tax exempt deposits, taxed withdrawals, and penalties for withdrawals before 59 ½ also applies.
That Was a Lot!
I know it may seem overwhelming at first, but it’s really not as difficult as it appears. Once you choose a plan and have it established, getting new employees enrolled will be as easy as making their ID cards.