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October 8, 2015

Key Advice for Clients Choosing a Small Business Retirement Plan


by  Denise Appleby,CISP, CRC, CRPS, CRSP, APA

Target audience: Financial and tax professionals

December 31 is the deadline by which employers must adopt a calendar year operated qualified retirement plan, if the objective is to make a tax deductible contribution to the plan for 2015. This means that you must act now if you want to target your share of the 28 million small business owners for your employer plan products.

For those of your clients who own small businesses and will be adopting retirement plans for their employees, care must be taken to ensure that the chosen retirement plans are suitable for the businesses, and that all compliance requirements are met.

Failure to operate the plan in compliance with regulatory requirements could result in loss of tax deduction for contributions, and even disqualification of the plan. Equally as important, choosing an unsuitable retirement plan, and/or selecting unfavorable elective features can be detrimental for your client.

There are many rules, regulations, features and benefits that should be considered. However, for the purpose of this issue, we are focusing on some key features that should be considered when choosing, establishing the plan and making contributions. .

Missing the deadline could mean ineligibility to adopt the retirement plan

As stated earlier, the deadline for adopting a qualified retirement plan is the end of the tax year for which plan contributions will be made and deducted. Qualified plans include profit sharing plans, 401(k) plans- including the Small Business-K plan, and pension plans.

For SIMPLE IRAs, the deadline for a new SIMPLE is October 1. An exception applies for business that comes into existence after October 1.Under this exception, the SIMPLE IRA must be established as soon as administratively feasible. Therefore, unless a client’s business meets this exception, it is too late for that client to adopt a SIMPLE IRA for 2015.

SEP IRAs must be established by the tax filing due date of the business, plus extensions. This means that if a client misses the December 31 deadline for a qualified plan, he/she can still make tax deductible employer contributions for 2015, if he/she adopts a SEP IRA plan by the SEP IRA deadline.

Eligible employees must be included

Many business owners set up retirement plans, because they want the tax deduction for the contributions, and/or they want to fund their own retirement nest egg.

Often, many are discouraged by the fact that they are required to cover their employees under the retirement plan adopted by the business. Covering employees usually mean making contributions to those employees’ accounts, which is an added- albeit deductible- expense for the business.

For those clients, the challenge becomes excluding as many employees as possible, for as long as possible. This can be accomplished by selecting the most restrictive options for the eligibility requirements.

For example, for a SEP IRA, an employer can exclude any employee who has not met any of the following requirements:

  • Worked for the business for three of the five preceding years,
  • Is at least age 21, and
  • Received compensation of at least $600 from the employer for the year

See Denise Appleby’s Retirement Plans Comparison Table for Small Businesses-2015 Plan Year for a high level comparison of the age and service requirements that apply to the various types of retirement plans.

Caution: For those who want to implement the most restrictive options, care must be taken to ensure that they do not exclude themselves. For instance, a 19 year old business owner will exclude himself/herself, if he/she chooses age 21 as the age requirement for eligibility.

Failing to include eligible employees can be costly; and required ‘corrections’ can include making missed contributions plus interest, and working with the IRS to correct the failure.

Vesting schedules can serve to discourage high employee turnover

The annual employee turnover rate is one of the factors that should be taken into consideration when choosing a retirement plan for a business. High employee turnover rates, can lead to increased cost of doing business, much of which stems from having to train new hires.

While offering a retirement plan for employees can serve to attract high quality employees, adding a vesting schedule can encourage employee loyalty.That is because an employee might be less likely to change jobs, if doing so means losing retirement benefits.

Choosing a vesting schedule

An employer may prefer if an employee ‘earns’ employer contributions through longevity service.For such an employer, this can be accomplished by implementing a vesting schedule.

Under the vesting schedule, employees would be required to accrue a number of years of service, in owner to ‘own’ (become vested), in the contributions made by the employer.

Employees who terminate from service before becoming vested would forfeit the employer contributions, or a portion of it, depending on the vesting schedule.

The following are the allowable vesting schedule:

Years of Vesting Service

Cliff vesting




0% or more



20% or more



40% or more



60% or more



80% or more



100% or more

Under the cliff vesting schedule, an employee who leaves before accruing three years of services would lose 100% of the employer contributions made to his/her account.

Under the graded vesting schedule, employees would lose 80% if they leave before accruing three years of service.

In order to determine which vesting schedule is better suited for an employer, an assessment of the employee turnover rate should be done.

Important: Contributions to SEP IRAs and SIMPLE IRAs cannot be subjected to a vesting schedule. If an employer wants contributions to be ‘earned’ under vesting schedule, a profit sharing plan should be considered.

Caution: Eligibility service and vesting schedule:

Employers can mitigate the cost of making employer contributions to a qualified plan- such as a profit sharing plan- by requiring that employees perform up to 2-years of service, before becoming eligible to receive certain employer contributions. However, choosing more than one year of service must be weighed against choosing one year or less with a strict vesting schedule.

If the employer requires employees to perform more than one year of service in order to become eligible to receive employer contributions, contributions to the plan will be immediately 100% vested. Therefore, if the employer wants contributions to be earned under vesting schedule, the year of eligibility service requirement must be one or less.

Be cautious about plans with mandatory contribution requirements

If a business is new or does not consistently make a profit each year, a plan with a discretionary contributing feature might be more suitable than a plan with a mandatory contribution requirement. Plans for which contributions are mandatory include pension plans, and profit sharing plans if that feature is elected.

Technically, SIMPLE IRA contributions are also mandatory. If the employer chooses the 2% nonelective contribution option, that contribution must be made to all eligible employees, whether or not they make salary deferral contributions. If the employer chooses to make matching contributions, they must be made for all employees who make salary deferral contributions.

Any contribution amount more than zero can be ‘too much’, if the employer have no profits from which to make the contribution. To prevent your client from facing such a predicament, recommend a starter retirement plan with a discretionary contribution feature, such as a SEP IRA or a profit sharing plan.

With a discretionary contribution feature, the employer can choose from year to year, whether to make contributions to the plan. This kind of flexibility is often a welcome feature for employers that do not want or cannot afford to commit to making contributions every year.

Meet deadline for making contributions

Missing deadlines for employer contributions could result in ineligibility for deducting those contributions; and, missing the deadline for deposing salary deferral contributions could result in penalties.

Employer contributions must be made by the tax filing due date of the business, including any extensions.

For plans with less than 100 participants, salary deferral contributions made by employees must generally be deposited to the employees’ accounts as soon as administratively feasible, but no later than seven business days after the amount is withheld from the employees’ pay checks.

A suitability assessment is essential

Just as a suitability assessment should be done for individuals when recommending a retirement solution, so must one be done for an employer. In fact, it may be even more crucial for an employer, as the employer could be required to continue the plan for at least a few years in order for the IRS to allow deductions for contributions.

In addition to the features highlighted above, a suitability assessment should take factors such as administrative costs, the cost of making contributions, and the level of importance placed on maximizing contributions to the plan.

Consider too that choosing one retirement plan might not mean having to stick with that plan. If a client adopts a SEP IRA this year- for instance- and it is determined that a 401(k) plan would be more suitable, the 401(k) plan can be adopted the following year.

Please see the Denise Appleby’s Retirement Plans Comparison Table for Small Businesses-2015 Plan Year for a high level comparison of how small retirement plans stack up against each other.



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