Investing in the Future
Company-sponsored retirement plans pay off for employers and employees.
By Bruce Bryen, CPA
An employer-sponsored qualified retirement plan is one of the best fringe benefits a laboratory owner can offer employees. Implementing one with a modest vesting schedule also gives the employer a distinct advantage in attracting new employees and retaining current staff. It creates a solid savings platform for the business owner and offers a tax-deductible component.
The income earned by the plan is tax-deferred until withdrawn from the trust, while payments into the retirement plan are tax-deductible immediately. The rate of its compound growth should easily exceed any traditional after-tax savings platform because of the nature of its non-taxable status until distribution. With a variety of options to choose from, owners can easily find a plan that benefits both their employees and their bottom line.
How Do They Work?
Depending on the type of retirement plan the lab owner adopts, employees can elect to defer thousands of dollars of pay and have those funds automatically deposited into their retirement plan as a tax deduction from their salary. One of the most common company-sponsored retirement plans is a 401K, which allows a deferral of up to $16,500 for people under age 50 and $22,000 for those over age 50. Based on a salary of $50,000, an employee under age 50 could report taxable income of only $33,500 to the IRS ($50,000 minus $16,500).
The lab owner would probably include a provision known as a “safe harbor,” whereby the business would add an additional 3% or 4% to the employee contribution, and the employee would be required to vest in order to earn the employer’s portion of the contribution. The same computation is effective for the lab owner as well.
What is Vesting?
Vesting is a process used to determine the rights of ownership to the funds a lab owner deposits on behalf of an employee. Employees always have full ownership of any money they defer from their paycheck, regardless of any change in employment status. However, employees may have to forfeit their employer’s matching contribution. Vesting typically operates on a schedule in which the employee earns 20% of the contributed match per year after the first calendar year. After 6 years (0% for the first year plus 20% per year for the next 5 years), the employee would have full ownership of the funds contributed or “matched” by the employer. Consequently, employees who leave prior to 6 full years would be leaving money on the table.
What are the Options?
There are only two types of retirement plans—a defined contribution plan and a defined benefit plan—but each has many variations. A lab owner with decent earnings can install a 401K as previously discussed, or a Simple IRA, which allows an employee under age 50 to defer up to $11,500 of pay and includes an employer match of 3%, similar to a 401K. With a Simple IRA, the match is limited to the deferral the employee opts to take. That means if the employee defers nothing, the employer has no obligation to pay any match. This is a big difference from a 401K, where a 3% match takes place regardless of the employee’s deferral. Profit-sharing plans and other plans that define the contributions allow lab owners with adequate earnings to defer their income as well as their employees’ income with reasonable annual administrative fees in ratio to the lab’s tax deductions.
What about Larger Businesses?
Businesses with good but moderate earnings typically opt for defined contribution plans, which usually have lower contribution and deduction levels. Larger operations with high earnings may want to adopt a more complex defined benefit plan based on criteria such as the employee’s age, job classification, number of years of employment, and other factors. In this type of plan, the contribution is not defined and the deduction is based on various factors determined by the employer. The plan is normally installed so that the owner can gain a large tax deduction that could be as much as $150,000 in 1 year, based on the circumstances. The annual administration costs are higher with this type of plan because deductions are based on the distribution of benefits from the plan and not on the contribution to the plan. The calculation is complex and therefore more costly.
With their professional knowledge and ability to consider an owner’s overall financial picture, certified public accountants serve as an excellent resource for laboratory owners who are unsure about which option is best for their business. A CPA can also help lab owners determine which personal assets may be used for inclusion with the business’s earnings so that they can enjoy additional deferrals of income and protect those personal assets from creditors.
Bruce Bryen, CPA, is managing partner of Bryen & Bryen LLP, Certified Public Accountants in Marlton, New Jersey. He can be contacted at 856-985-8550 Ext 112 or at firstname.lastname@example.org.