3 Mistakes to Avoid When Starting a Retirement Plan

Don't make these common mistakes when setting up your company retirement plan. We work with businesses every day who have told us they wish they had known these key tips before getting started. Take a look at the three common mistakes to avoid below.

1. Choosing the Wrong Plan Type

There are several plan types to choose from when starting a retirement plan—401(k), SEP IRA, SIMPLE IRA— but they aren’t all created equal. Selecting the right plan type for your business can significantly affect your ability to save for retirement, which is why choosing the wrong plan type is the most common mistake business owners make when starting a retirement plan. Most of the time a 401(k) is the plan type that makes the most sense, because a 401(k) offers maximum tax advantages as well as maximum flexibility. However, many business owners open SEP or SIMPLE IRAs instead, and regret it. See below for a list of drawbacks when it comes to SEP and SIMPLE IRAs:

SEP IRA Drawbacks: 

  1. Employer contributions are required on an annual basis, and must be made pro-rata. This means you may be required to give your employees up to 25% of their income annually in the SEP IRA.
  2. Employees aren’t able to contribute their own money to the plan
  3. All employees must be included, including part time and seasonal employees
  4. All contributions are immediately vested 

This means you may be required to give your employees up to 25% of their income annually in the SEP IRA.

SIMPLE IRA Drawbacks:

  1. The maximum annual contribution is only $13,500 (significantly lower than a 401(k) plan), which is rarely enough to help business owners save for retirement or help with tax mitigation 
  2. Employer contributions are required on an annual basis (3% match or 2% non-elective), making this plan relatively costly when compared to its limited tax benefit
  3. All employees must be included, including part time and seasonal employees
  4. All contributions are immediately vested 
  5. SIMPLE IRAs have very strict rules about when they can be upgraded to a 401(k), it must be done in Q4 before November 1st. This often causes business owners to be trapped in their SIMPLE IRA for years, which can severely limit their ability to save. 

We’ve made it easy to find out which plan type may be best for your business with our Plan Selector Tool

This often causes business owners to be trapped in their SIMPLE IRA for years, which can severely limit their ability to save. 

2. Not Hiring a Specialized Adviser

Business owners have options when it comes to hiring an adviser for the retirement plan.

Depending on who you hire, you’ll find the amount of time you have to spend on plan administration can change dramatically, in addition, each adviser provides different options when it comes to investments and fees. These differences can add up to significant financial impact, which is why choosing a generalist (or no adviser) instead of a specialist is the 2nd common mistake business owners make when starting a retirement plan.

There are 3 options when it comes to hiring an adviser:

  1. No adviser—Start a plan without an adviser. This option means the business owner is on their own when it comes to implementing plan responsibilities, including choosing investment options. This may seem like a low cost option, but fund fees, fund performance, and extra administrative work can make this option much more costly than it seems. 
  2. Non-specialist adviser—Start a plan with an adviser who doesn’t specialize in retirement plans. In this scenario, the adviser might help with some education or investment services, but the bulk of the plan responsibilities still fall to the business owner 
  3. Specialist adviser—Start a plan with a specialized adviser who has dedicated expertise in retirement plans, and will help the plan connect with other providers as necessary. In this scenario, the business owner is able to delegate most of the plan responsibilities to the plan providers. 

Often times business owners who work with a non-specialized adviser (or no adviser at all) end up feeling overwhelmed by the retirement plan. This is especially true for small businesses who don’t have an HR department, leaving all the responsibility to the business owner. The easiest way to avoid this mistake is to know your options, and consider a retirement plan adviser that helps you to delegate plan responsibilities

3. Waiting Too Long

The 3rd common mistake business owners make when starting a retirement plan is waiting too long to start. Too often business owners put off the decision to start a retirement plan, and then end up kicking themselves, wishing they had started saving sooner. If this sounds like you, there is good news. The SECURE Act (legislation passed in Dec 2019) makes it easier and more affordable than ever to start a retirement plan now. See below for information on why now is the best time to start a retirement plan.

Tax Credit:

If you’ve ever wondered when is the best time to start a retirement plan, the answer is right now! This is because there is a new tax credit available (as of 2020) for businesses starting a retirement plan. The tax credit is applicable for the first 3 years of the plan, and can be as high as $16,500. It’s not a tax deduction, it’s a bona fide tax credit, which means actual money in your pocket. This provision makes it easier than ever for business owners to avoid the mistake of waiting too long to start a retirement plan.  Here is a quick summary of how it works below, to learn more about the tax credit, check out our Tax Credit FAQs:

  

  1. The annual tax credit will be the greater of $500, OR $250 for every eligible NHCE
  2. The annual tax credit may not exceed $5,000 or 50% of total eligible plan costs 
  3. Plans that add automatic enrollment get a bonus tax credit of an additional $500 per year

The tax credit is applicable for the first 3 years of the plan, and can be as high as $16,500.

401(k) Deadline Extension: 

Prior to 2020, many business owners would wait until tax time to consider starting a retirement plan. This was problematic because historically 401(k) plans couldn’t be started after the calendar year had ended. This forced many business owners to start SEP IRAs or SIMPLE IRAs instead of a 401(k) plan, even though a 401(k) may have been the better suited plan type. The good news is, the SECURE Act extended the deadline to start a 401(k) plan, which means now a 401(k) plan can be started after the calendar year ends, so long as it’s done prior to the tax filing deadline (including extension). This is great news for business owners because it makes it possible to start a 401(k) plan for the prior calendar year!

Deadline to start a 401(k)

Now you know the 3 most common mistakes business owners make when starting a retirement plan. 

 

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