Which is Better for my Company - 401k vs IRA

The decision about what type of retirement plan to offer to your employees can be a difficult and complex one.  There are many different options and each has advantages and disadvantages that must be considered.  Because of the complexity of the types of plans and decisions involved, many companies choose to use the services of a Professional Employer Organization (PEO) to assist them in making the right decision for their company.

There are two main types of retirement plans that employers often consider

• 401k Plans – (or 403b plans for nonprofit organizations) – a 401k plan is a form of profit sharing that can be offered to employees.  There may be an employer contribution or match, as well as the employee contributing money from their salary on a pre-tax basis.

• IRA (Individual Retirement Arrangement) – is an individual saving plan, which allows money to be set aside for retirement and generally are not taxed until taken out at retirement.  There are several types of including:

• SEP – Simplified Employee Pension Plan – allows companies to put aside money for their employees’ retirement (or their own if self-employed).

• SIMPLE IRA (Savings Incentive Matching Plan for Employees) – designed for small employers (no more than 100 employees) to be able to make contributions toward employees’ retirement (or their own).  Employees can make contributions from their paychecks and employers can either make a matching contribution or no contribution.

These are several benefits to setting up a retirement account (regardless of the type) for an employer including:

• Contributions are tax deductible
• Assets in the plan grow tax-free
• Business can receive tax credits or other incentives for starting a plan
• It’s a great way to attract and retain employees

Advantages, Disadvantages and More Information

• 401K Plans - for an employer who wants their employee to participate in contributions to their retirement plan, a 401k plan can be a great way to go.  These plans allow employers to establish matching funds if they choose and to create vesting schedules that determine how many years the employee must work for you before they own those matching funds or contributions that you’ve made.  401k plans can be established by any company, but typically are used by employers with more than 100 employees.  However, any company can set up a 401k plan if they choose as long as they have at least one employee.  Withdrawals are permitted in some cases, but may be subject to federal taxes and early withdrawal penalties (if relevant).  The plan may also permit loans or hardship withdrawals.

401k plans do involve a number of administrative tasks on the part of the employer, such as annual filing of a 5500 and annual non-discrimination testing to ensure plan does not discriminate in favor of highly compensated employees.  These tasks can be an added “headache” to some employers. 

401k plans also have a number of administrative costs associated with them, in addition the staff time necessary to manage them.  These costs can include administration fees for the plan recordkeeping, accounting, legal and trustee services necessary to manage the plan.  Investment fees are involved with the managing of plan investments.  These fees are deducted from the investment returns.  Individual service fees may also be charged for option features under a plan, such as taking a loan out against the account.

• SEP – These plans are generally very easy for employers to set up and maintain.  Any employer with one or more employees is able to establish a SEP, but are typically chosen by employers with less than twenty employees or those who are self-employed.  There are no annual filing requirements for employers and the plan does not permit employee contributions, which can reduce the administrative time necessary to maintain the plan.  However, it often does not give employees a sense of ownership or involvement in their retirement planning process.  Employers are able to decide from year-to-year if they will make a contribution, so this offers flexibility if a business has a bad revenue year and is not able to afford the added expense.  Employee withdrawals from the plan are permitted subject to federal taxes and early withdrawal penalties (if relevant).

• SIMPLE IRA – this involves a salary reduction plan and any employer who has 100 or less employees and does not have another type of retirement plan can offer this option to their employees.  There are no annual reporting requirements for the employer, as the financial institution that is administering the plan will handle the reporting.  The employee can decide how much he/she wishes to contribute within certain IRS limits and then the employer can establish a matching contribution if they choose. Employee withdrawals from the plan are permitted subject to federal taxes and early withdrawal penalties (if relevant).

As you can see the types of retirement plans and issues involved with each are complex and often difficult to understand.  The decision can be affected by the size of your organization, the desire for employee contributions and your ability/interest in making employer or matching contributions.  The process can often be a much smoother one through the use of the services of a PEO who has the expertise and experience in which plan might be right for you.