Small Business Retirement Plans
Small Business Retirement Plans- Big Advantages in 401K and Cash Balance plans Versus IRA’s
Small business owners improve their business by offering themselves and their employees a retirement plan, usually a 401k plan. A different kind of plan, called a defined benefit plan, retains more control with the plan sponsor. It has significant tax advantages and a much higher contribution limits. Creating and implementing a retirement plan helps employers save more money for their retirement in a tax efficient way, as well as help attract and retain valuable employees. Owners must understand their specific kind of retirement plan structure, either 3-21 or 3-38, and how that choice affects their potential liability. They have to be aware of the complex ERISA laws regarding how the plan is set up, administered, and operated for employees. Employees need counseling with getting enrolled, training, and education on retirement choices, and then consistently contributing towards their retirement. These are areas where Y H & C Investments helps a small business evaluate the current status of their existing plan and improve it in the most efficient way possible.
Y H & C Investments and Business Owners- Making Informed Decisions and the Investment Policy Statement
Y H & C Investments specializes in making accurate, informed decisions on investment choices. In consultation with the sponsor, we create an investment policy statement to document the plan decisions about return objectives, risk tolerance, tax implications, asset mix, fund and instrument possibilities, and other considerations. You can look at our investment process to get in indication of how we evaluate an asset.
We work with your business to set up your retirement plan so it fits the demographic profile of your employees. The choices for participants are cost effective, diversified, and are aligned with their specific life situation. The payroll provider information is integrated with the TPA so all participant eligibility requirements, notices, and account information is handled through an efficient administration partner for the sponsor. We use Vestwell and other service providers, which specializes in this aspect of the plan. Vestwell has an open architecture provider, and offers a wide variety of investment choices which are conflict free from payments by fund families and insurance companies. By offering low cost possibilities, the priority is having participants benefit from their retirement choices.
2021 Contribution Limits
If you are a plan sponsor, the combined employer and employee contribution limit has been raised to $64,500.00 per year. It includes the profit sharing piece of a plan. The 401K contribution limits for participants is now $19,500.00 per year. If you are an employee age 50 or over, you can contribute an additional $6,500.00 per year, called a catch up contribution. Cash balance plans have much higher limits, up to 343,000 per year. The limits are based on the retirement end goal objective and the amount of annual compensation in the business. Notice the vast difference between the contribution limits in a cash balance plan or 401K plan versus an IRA. In an IRA, either Individual, Roth, or Rollover, the maximum contribution limit is $6,000 per year if you are under the age of 50, or $7,000 if you are over 50.
Why Fees Matter
Your 401(k) fees matter. Imagine that you have a $100,000 balance and that you are 30 years away from retirement. Here are three investment possibilities in a fund with an annual 6% rate of return and different annual expenses (the automatic fee you pay on your investments). These expense ratios can be called “fund fees” and they are usually the most expensive when it comes to 401(k)-related fees, so let’s focus on this type of fee.
|Annual 401(k) fee (expense ratio)||Balance After 30 years||Difference from 0% scenario|
In our example, a 0.25% annual expense ratio means that you pay $250 in 401(k) fees for a balance of $100,000. While $250 per year may not sound like much, it really adds up over a long period of time. This is why you need control your 401(k) fees.
If you want more information about fees, maybe click this link to Dave Ramsey’s explanation-
Servicing the Retirement Plan
When you work with Y H & C Investments, participants are informed about the advantages of using the plan (pre tax contribution helps lower taxable income), enroll, and we emphasize consistently contributing. A sponsor can have participant contributions annually increased by implementing automated escalation through the TPA. Contributions typically range from 3-5% of the paycheck. Participants have regular consultation with the advisor, which means quarterly or semi-annual reviews (using a variety of methods, including on site visits or mobile devices and virtual consultations), along with an annual review. The reviews are to make sure the participant is on track to meet their retirement goals. Participants have 24 hour a day, 7 days a week access to their retirement account through Vestwell, and they can always see where their account stands with respect to the value of the account and what they own.
Learning More About The Different Pieces of the Retirement Plan
If you are not familiar with retirement plans, here is a brief overview. The business owner, called a sponsor, needs multiple pieces working together efficiently to have an effective retirement plan. The first piece is the payroll component, where employees pay is set up, calculated, and processed. Retirement contributions come out of the payroll, from the employee and potentially matched by the sponsor, and must be integrated into each employees specific retirement account in a defined contribution plan, like a 401K, Roth 401K, SEP, or 403 B plan.
A different kind of plan, called a defined benefit plan, retains more control with the plan sponsor. It has significant tax advantages and a much higher contribution limits. The most common defined benefit plan for small businesses are cash balance plans. The cash balance plan is a qualified plan, and participants have their own accounts. The investment piece of a cash advantage plan typically involves an interest credit through instruments related to treasury bonds.
The second, third, and fourth pieces revolve around the financial advisor, who sets up the plan with the help of a third party administrator. The third party administrator is the record keeper for the retirement plan for all of the eligible participants in the plan. The third party administrator, or TPA, is responsible for notifying participants of different eligibility and enrollment deadlines, distributions, and documenting investment performance. The TPA also sets up the custody of the assets. Custody of those assets is usually held in a trust. With all of these different pieces, the retirement system is currently quite inefficient, with participants paying excessive fees.
Where are the high costs typically located?
The fees revolve around large payroll providers and insurance companies. In many cases, they provide all of the different pieces of the retirement plan (financial advisory, risk management, and the TPA component), even though their best skill is administering payroll. The payroll providers and insurers are inefficient primarily because they are compensated by mutual fund families for fund choices offered to participants. The funds are typically far more expensive than index funds or ETF’s. If the mutual funds outperform indexes, then the higher fees are justified. However, academic research shows that 80% or more of the mutual funds do not outperform indexes over a long period of time. Consequently, participants suffer, and the payroll provider and insurers benefit.
If you are a small business owner and need help planning and managing your retirement plan, you might take a look at our video on the subject.