Employee retirement plans can benefit both employers and employees.
- Employee retirement plans offer a way for employers to help their workers save money for retirement.
- There are several different types of retirement plans you can offer, including 401(k) and SIMPLE IRA plans.
- Offering retirement plans to employees is a good way to retain and attract top talent.
- This article is for small business owners wondering if they should consider offering an employee retirement plan and what they should look for in a provider.
It takes a lot of planning and preparation for employees to enjoy their retirement years. While most people want to get to a point where they don't have to trudge into work each day, that time may never come if they don't prepare financially. While the burden might be on employees to save enough for retirement, many believe that employers should share that responsibility.
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What is an employee retirement plan?
To help employees make sure they have enough money saved for their golden years, many businesses offer an employer-sponsored retirement plan.
"At its most basic level, it's a savings vehicle that employers can choose to offer to their employees that allows those employees to save for their retirement on a tax-advantaged basis," said Chris Augelli, head of retirement channel marketing for U.S. intermediaries at T. Rowe Price.
With employee retirement plans, workers set a percentage of their paycheck to invest in the plan each pay period.
"It comes right out of the employee's paycheck each and every time they are paid," Augelli told Business News Daily. "It automatically comes out pre-taxed and automatically gets invested into the plan." [Looking for an employee retirement plan for your business? Check out our recommendations for the best employee retirement plan providers.]
Key takeaway: Employee retirement plans are a benefit offering that allows employees to set aside a certain percentage of each paycheck for retirement.
How do employee retirement plans work?
Employer-sponsored retirement plans are common in the workplace, and it's important to understand how these plans are structured and how your company can get the most out of your benefits package.
Linda Wolohan, communications manager for investment management firm Vanguard, said employee retirement plans come in a variety of shapes and sizes.
"The type of plan can vary in features, and can vary in terms of whether the employer makes all the contributions to the plan, the employee makes all the contributions to the plan, or whether it's a joint effort," Wolohan said.
A joint effort means the employer offers a matching contribution. Meghan Murphy, vice president and team lead for life events at Fidelity Investments, said that in addition to the money the employees invest on their own, many businesses offer this type of matching program. The employer matches a certain percentage of the employee's contribution with their own contribution to the employee's retirement account.
"A common match is 100% on the first 3%," Murphy said. She added that if the employee goes over that 3% – contributing 5% of their paycheck, for example – the employer would just match the 3%.
With the uncertainty surrounding Social Security, employer-sponsored retirement plans have become much more important in recent years, Augelli said.
"People really need to be taking the onus for their own savings and personal retirement, and there is no better way to do that than to be [with] an employer who is going to offer you one of these plans," he said.
Key takeaway: Employee retirement plans allow workers to save pretax dollars for retirement in an investment account that can grow over time. Some employers offer matching contributions to encourage employees to participate.
Benefits of employee retirement plans
There are many major benefits in offering retirement benefits to your employees, from increasing productivity to attracting new talent. An employee retirement plan can be the backbone of your benefits package and an essential ingredient of a positive company culture that increases employees' general well-being.
To break down the importance of employee retirement plans, we'll address possible benefits from two different viewpoints: employees and employers.
1. You can save money for retirement now.
Employees who take advantage of employer-sponsored retirement plans "will be ready when retirement comes," Murphy said. "Our goal is to allow people to retire and live the same lifestyle they are accustomed to, but in order to do so, they need to save."
The earlier in their careers employees start using these plans, the more advantageous they can be.
"If you start saving when you're young, you can save a lot of the dollars that you're going to put into the plan, because you have such a longer time horizon over which those dollars are going to be earning [more money]," Augelli said. "Put those dollars to work for you, and take advantage of a longer time horizon – and you don't even have to invest as many dollars to get to a healthy balance."
Murphy said the difference in starting to save for retirement at age 25 versus 35 is enormous.
"The earlier you start to save, the more likely you will be likely to reach the amounts that are necessary to survive in a retirement that could be 30 years," she said.
2. You get tax advantages.
Employee retirement plans come with many tax advantages. Augelli said most retirement plans allow employees to contribute money on a tax-free basis; the money isn't taxed until it is withdrawn from the account.
"So, if they go into retirement and take a withdrawal out of the plan, at that point, they are taxed," Augelli said. "The assumption [is], though, if they are in retirement, they are likely going to be in a lower tax bracket than they were at the point at which those dollars were first earned."
Augelli said the contribution dollars go in on a pretax basis and get invested from every single paycheck, and the earnings start to compound. "Those earnings have accumulated pretax, which is a huge, huge advantage."
"By contributing pretax dollars into their retirement plan, employees are not only saving for retirement but also lowering their current taxable income," Wolohan said.
She said this is because the money is deposited into the retirement account before taxes have been deducted. "Say you earn $30,000 a year and contribute 12% – or $3,600 – to your company's retirement plan. That reduces your current taxable income for the year to only $26,400."
3. It's free money.
The matching contributions are also a huge benefit to employees participating in a retirement plan.
"If an employer is offering you a matching contribution, that is one of the few things in life that truly is free," Augelli said. "That can quickly accumulate into a nice contribution that they are going to make into your retirement account."
Because the money comes out of your paycheck each month, employer-sponsored retirement plans offer a simple way to save for your golden years, he added.
"Savings in these plans is easy and takes the indecisiveness out of it," Augelli said. "It is a great way to invest in your own future."
1. Employees expect retirement plans.
While the advantages to employees are fairly obvious, employer-sponsored retirement plans are also beneficial to the businesses that offer them.
Retirement plans are an important part of compensation, Augelli said. "Employees are looking for an employer who is going to offer them access to a retirement plan."
The plans are especially enticing to employees when they include a matching contribution from the employer.
"It is really seen as a value in the workplace," Murphy said.
2. Retirement plans attract new talent.
Ensuring your employees are financially prepared for their retirement also benefits your business by helping you attract new employees, Murphy said. She said employer-sponsored retirement plans are a big part of a business's workforce planning.
Without some help in saving for retirement, Murphy said, employees might keep working for your company past typical retirement age just to earn a paycheck, which hurts your chances of hiring new employees who will bring fresh ideas to the table.
3. It reduces employee turnover.
Many retirement plans offer vesting schedules, which can benefit employers. Vesting schedules are tied to matching contributions and ensure that employees who want all of the money their employer has contributed to their account don't immediately take their money and run. Augelli said many businesses use vesting schedules as an incentive for their employees to stay with the company.
For example, a typical vesting schedule is five years. Each of the first five years that an employee works for your company, they would earn 20% of the matching contributions, Augelli explained. If the employee were to leave after two years, they would get only 40% of the money your company contributed to the retirement account.
"You would keep that 40%, and the other 60% is a forfeiture," Augelli said. "It is a cost-management tool for the employer."
Aside from this, employees in general want to work for a company that has their best interests at heart. A 2017 Glassdoor survey found that 4 out of 5 employees would prefer benefits over a pay raise, with 401(k) plans ranking in the top five requested benefits.
Key takeaway: Employee retirement plans offer benefits for both employees and employers. For employees, it is a vehicle to save money, has tax advantages and can result in free money if the company offers a matching contribution. For employers, it can help attract and retain employees.
Types of employee retirement plans
Employers have many retirement plan options, each with pros and cons. For small businesses, the most popular options are 401(k) plans and Savings Incentive Match Plan for Employees Individual Retirement Accounts (SIMPLE IRAs).
Augelli said the SIMPLE IRA was designed specifically with small businesses in mind because these plans can be set up quickly, for a low cost.
"They really are meant to be more of a one-size-fits-all solution – basic in their design, but offered at a very reasonable cost," he said. "It's kind of like a starter 401(k) plan."
With a SIMPLE IRA plan, employers are required to make either matching or nonelective contributions and must allow all employees to participate in the plan. Employees are only allowed to contribute $11,500 per year to the account. These plans are generally available to businesses with fewer than 100 employees.
Small businesses that don't offer a SIMPLE IRA typically offer a 401(k) plan. Augelli said 401(k) plans provide employers with many more options and give employees the chance to contribute more money – up to $17,500 per year.
"A 401(k) plan offers a lot more flexibility," he said. "They have more flexibility in terms of which types of employees are eligible to take part in the plan, how fast employer contributions may vest or be earned by the employees, and you can defer more."
Murphy said that 401(k) plans were originally meant to be a supplemental source of retirement funds, since many employers also offered their workers some type of pension plan. However, over the past decade, many businesses have eliminated their pension plans, putting greater emphasis on the 401(k).
"It is no longer supplemental," Murphy said. "The 401(k) has become the primary savings vehicle for the majority of Americans who will retire in the upcoming years."
SIMPLE IRA vs. 401(k)
When employers are choosing between a SIMPLE IRA and a 401(k), they should consider the size of their business.
"If this is a business with five employees or less, [a] SIMPLE IRA is probably going to be the right vehicle for you," Augelli said. "You aren't going to have a lot of need for customization, since you are most likely a smaller, younger firm."
Augelli said ADP, where he formerly served as vice president of product marketing and business development, suggests that businesses in growth mode with more than five employees strongly consider the 401(k) plan.
"[The 401(k) will] give you those customizable levers to help you manage your expenses, help you manage different populations of employees in different ways, and also offer the maximum savings opportunity," he said.
Roth 401(k) and IRA
Employers' other retirement plan options include Roth 401(k) plans and IRAs. In these plans, taxes are paid on contributions upfront when they are invested in the account, rather than when they are withdrawn in retirement.
Simplified Employee Pension IRA
Simplified Employee Pension (SEP) IRAs are another option for employers. According to the U.S. Department of Labor, SEP plans allow employers to set aside money in retirement accounts for themselves and their employees. Under a SEP, an employer contributes directly to traditional individual retirement accounts (SEP IRAs) for all employees.
These retirement plans mirror 401(k) plans, except they're offered to state and government employees.
Key takeaway: There are various types of retirement plans, including 401(k), SIMPLE IRA, SEP IRA and 457 plans.
How to choose a retirement plan provider
While a good price and solid investment options should be top priorities when you're choosing a retirement plan provider for your business, you may want certain features to ensure you and your employees get the most out of the retirement plan. The retirement experts and business leaders we spoke to offered some tips on features to look for in an employee retirement plan provider.
Considering most small business owners are incredibly busy, they should be looking for an employee retirement plan provider that will handle the entire administrative burden and make the process easy for them, Augelli said. That includes making sure the deferrals automatically come out of each paycheck and are properly deposited into the right investments.
"These plans can be complex, and they can be time-consuming, so you want to go with an administrator who is focused on offloading a lot of your administrative burden," Augelli said. "You want to choose someone who is going to do that work for you, who is going to make it easy, take [up] less [of your] time and keep you compliant."
The best employee retirement plan providers offer educational tools to help employees with the daunting task of saving for their retirement, said Julia Missaggia, director of talent for the communications firm Brownstein Group.
"We chose a retirement plan provider that has online calculators to help our employees estimate their retirement needs," she said. "These can be accessed at any time, and they help our employees make informed decisions when it comes to their accounts."
Missaggia said employers should also choose a retirement plan provider that allows employees to easily keep tabs on their retirement accounts.
"If you don't know how your account is performing, you don't know what adjustments to make," she said. "Therefore, we made sure our retirement plan website offers employees detailed information regarding the daily performance of their portfolio."
Scott Swisher, former owner of Shenandoah Valley Wealth Management, said it's critical to find an employee retirement plan provider that doesn't take kickback payments from any of the mutual-fund companies in which they invest. Rather than choosing to invest in funds that offer employees the greatest chance to make money, providers that accept kickbacks are often selecting plans that give them the best chance to make money, he said.
"Retirement plan providers who accept kickback payments from mutual-fund companies have a huge incentive to include [those] mutual funds in 401(k) plans, because if they do, they make more money, plain and simple," Swisher said.
Employers should look for an employee retirement plan provider that will send representatives to meet with employees face-to-face, to discuss both the retirement plan and retirement process, said Amy Gulati, human resources business partner with outsourcing and recruiting firm Helios HR.
"It allows people to discuss the company's plan but also talk about their retirement savings goals in general," she said. "It's a really benevolent thing for employers to do and is usually very popular."
Murphy said automation tools are a nice feature some employee retirement plan providers offer. These tools include automated investment options for employees who aren't sure where to invest their money, and automated enrollment options, which automatically sign up all new employees for the retirement plan as a way to encourage them to participate.
"There is [also] an auto-increase that, once people are in the plan and actually contributing, helps them bump up their savings a little bit each year," Murphy said.
It's also important to find a retirement plan that gives employees constant access to their accounts through their mobile devices, Murphy said.
"Having a good mobile strategy makes it really easy for people to save," she said. "They can then access their accounts on their phone or tablets."
Key takeaway: Look for an employee retirement plan provider that takes on the administrative burden of the plan, offers online and mobile access, and provides educational and automation tools to help employees maximize their savings.
Matt D'Angelo contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.