3 retirement plan options for small-business owners

Small businesses that offer 401(k) plans may not be aware of the additional retirement plan options available to complement their 401(k) offerings. There are several plan design options that have the potential to save them hundreds of thousands of dollars off their annual tax bill and allow participants to accumulate a much larger nest egg.

COMBO PLANS THAT PROVIDE SIGNIFICANT VALUE TO SMALL BUSINESS CLIENTS

There are currently 61.2 million small business employees in the United States, who make up nearly half (46.8%) of the U.S. workforce, according to the Small Business Association. Some of the biggest challenges for small businesses today are attracting and retaining top talent by offering competitive benefits that prepare their employees for retirement, and maximizing owner contributions up to the legal limit.

There are a number of retirement plan options available that can benefit small businesses, particularly ones that:
• Are sole proprietorships or S corporations.
• Employ 50 or fewer individuals.
• Provide professional services (such as medical, legal, industrial).
• Are tightly held businesses made up of a small group of highly compensated employees, such as a family-owned business.

If any of your clients meet this criteria and want a break on their tax bill, or want to make larger contributions to their retirement accounts, consider the following plan designs to complement the 401(k):

401(k) PLUS CASH BALANCE PLAN

This is a winning combination for any employee and is ideal for business owners who are starting to think about retirement but haven’t put enough money aside. For example, in 2022 a 55-year-old can contribute $27,000 tax-deferred to a 401(k) and an additional $222,200 to a cash balance plan.

Benefits of a cash balance plan can include higher contribution maximums, federally protected guarantees, portability, and tax advantages like tax-deferred compounding. A cash balance plan can be used as a recruitment and retention tool in which high earners can accumulate high balances for annuity or lump-sum payouts, and benefit from tax savings. Funded 100% by the employer, younger workers find the portability and simplicity of cash balance plans attractive. Cash balance plans offer greater funding flexibility than defined-contribution plans and may also be less costly than a comparable profit-sharing plan if investment returns are higher than the credited interest rate.

A cash balance combo plan provides the largest potential savings options of the three plan types explored in this article.

NEW COMPARABILITY PROFIT-SHARING PLANS

This plan design offers a lot of flexibility to small business clients who are interested in leveraging their retirement plan offerings to attract and retain talent. One of the unique features of new comparability plans is that business owners can determine specific contribution and benefit amounts for each individual employee in the plan.

This is a type of “cross-tested” plan within a 401(k) and it's the next most powerful on this list, but the plans only work for certain types of small businesses and must pass a special IRS “general test” to prove they don’t discriminate in favor of business owners or other highly compensated employees. New comparability or age-weighted plan designs are a great way to help business owners and highly compensated employees get closer to their Section 415 limitations, but sometimes they don't work. That's where our next plan design comes into play.

TRIPLE STACK MATCH

This plan design strategy is based entirely on deferrals and matching contributions. It allows business owners to contribute the retirement plan maximum under Section 415 without nondiscrimination testing. This is most commonly found where there isn't an age variance between the owners and highly compensated employees.

A triple stack match provides three contribution levels within a retirement plan:
1. Safe harbor match — up to 4%.
2. Fixed match — ideal for successful business owners and key employees, with deferrals of up to 6%, determined by the Section 415 annual additions limit..
3. Discretionary match — up to 66 2/3% of the employee deferral up to 6% (limited to 4%)

Another potential candidate for a triple stack match is a business that's classified as an S corporation, and as a result, the owners are highly compensated employees who take only limited W2 compensation. For that reason, it can serve as an excellent tool for companies looking to stand out and add value through their retirement plan, whether it's to recruit new talent or retain valued employees

DESIGNING THE RIGHT PLAN WITH YOUR CLIENTS IN MIND

These plan options can be extremely attractive to the right business owner, but designing them takes expertise, consultation and a solid understanding of the objectives of the employer, along with their employee population, ages, salaries and a number of other considerations.

Step one in any scenario is to partner with a certified public accountant and third-party administrator. The CPA can be a key player in understanding the tax code, leveraging the qualified plan and realizing significant tax savings. CPAs can often help business owners understand the tax benefits and the impact on their cash flow. TPAs are retirement plan design experts and can help make sure the plan meets all rules and requirements. Finally, it’s important to partner with a record keeper that has a significant depth of expertise and experience in creating these less common, yet effective plan designs.

By leveraging these experts and one of these plan designs, you can be a hero to your clients for providing creative solutions for important business needs. Small business owners and high-earning individuals can have the opportunity to significantly increase their tax-qualified retirement savings, reduce their taxes and be better positioned for retirement.

Joel Mee is senior director of retirement plan sales at Standard Retirement Services and a registered representative of StanCorp Equities Inc., a registered broker-dealer.