July 25, 2018
How to Stop Working: Perfecting Employee Retirement Plans
As of this past June, the number of job openings in the U.S. is now greater than the number of unemployed. I recently discussed how this situation means that it is more important than ever to have competitive benefits offerings to both attract and retain the top talent that you need to keep your business growing. In looking at what to offer, an important question to ask is what goal are your employees trying to achieve.
That answer can take many shapes. Some people derive joy from working in a field they are passionate about. Others seek advancement and affirmation, while still others focus on earning as much as they can. There is one goal, though, shared by almost every employee (and business owner for that matter), and that is to stop working someday. Retirement savings and planning, therefore, are of paramount concern to many employees, and only more so the older they get.
When it comes to the employer’s role in retirement benefits, a lot has changed over the past few generations. A few decades ago, it was generally seen as the company’s responsibility to pay for retirement for its employees who had served long and diligently. That societal view has changed markedly, and not least due to the fact that promises of pensions and healthcare proved very hard to keep. The general view today is that a person is responsible for their own retirement savings and that the employer’s job is to help. I lay out this history to preface the most basic concept of employer-provided retirement benefits, that of defined benefit versus defined contribution.
Who Foots the Bill
A defined benefit plan is exactly what it says, the benefits (or payouts) during retirement are defined ahead of time, usually in current dollars at a rate indexed to some type of inflation indicator and which increases with years of service to the company. All burdens in maintaining the plan are on the company’s shoulders. It can save, spend, payout and invest its capital however it likes, but only after meeting the payout burden as defined.
A defined contribution plan flips that burden. An employee and employer both define contributions to a retirement account (commonly a 401K, though there are others), but the benefit those contributions will have in the future is uncertain and depends on the performance of the investments made with those contributions.
It is nearly unheard of today for a small business to enter into a defined benefit plan, so this discussion from here forward will assume that you as the business owner will choose a defined contribution plan.
A Taxing Situation
The “magic” in any type of qualified retirement plan comes from its tax treatment. The government does not want to shoulder the financial burden of providing for millions of starving retirees, therefore it offers tax incentives for both employees and employers to plan and save for retirement.
The terms you often hear in this space such as “401K,” “403B” or “Roth IRA,” all refer to specific tax codes. The type of plan (tax code section) you choose depends on the tax incentives, i.e., whether the contributions or the distributions occur tax-free. Funds from 401Ks are taxed at distribution, for instance, while Roth funds are taxed at deposit and are therefore tax-free at distribution.
The next piece of the tax-incentive puzzle is “qualified” versus “non-qualified” accounts. In all qualified retirement plans, the investments grow tax-free while they remain in that plan. This is a massive advantage over non-qualified investments in which the employee (and sometimes the employer, depending on how the vesting program is structured), will pay capital gains taxes and, potentially, regular income taxes on the profits each time funds are reinvested. That reinvestment can be often depending on the trades the employee and/or the mutual fund managers make. In other words, qualified plans put the full power of compound interest to work for you, rather than giving that growth a haircut every few months or years.
The last decision you’ll need to make is defining who makes the contributions to the retirement fund and how much. Many employers match what the employee contributes up to a certain amount — and that’s a big piece of what employees look at in evaluating benefits packages. According to Vanguard, a leading retirement plan provider, over 90 percent of employers provide some kind of match and the median match amount is 3 percent of an employee’s salary. This means an “average” 401K plan involved an employer matching what an employee contributes up to what equals 3 percent of their salary (Federal law sets limits on total yearly contributions to 401Ks and other retirement funds). This can be done dollar for dollar (requiring an employee to contribute only 3 percent to get 3 percent) or on some smaller basis like $.50 to the dollar (requiring an employee to contribute 6 percent to get 3 percent).
At the high end, employers match up to 6 percent. At the low end there’s no match at all. This is an important point to understand: As an employer, you do not have to match contributions, say, if your budget is tight. You can also choose what’s called a “vesting schedule” for employer contributions in which you might require a year of service or more before the business’ contributions to the fund officially become the employee’s money. Either way, such plans cost you nearly nothing, but still benefit employees because you will have unlocked the “magic” of these qualified plans for them.
Retirement Plans Are Good Business
There are lots of options out there, and a financial advisor can help you sort figure out what’s right for you. Generally, you will not have to pay any kind of fee for a consultation. The bottom line, though, is that if you are not offering a plan, you should be, at the very least a plan without a match if cash is tight. Your employees will appreciate the ability to save for their retirement tax free, even if it’s all their own money, and you will appreciate the reductions in turnover and increases in morale that result when your workforce feels you are invested in their future.
About the Author
Josh Fiorini has a wealth of experience in manufacturing, business management, and finance both within and without the firearms industry. He was the CEO of PTR Industries, Inc. for seven years and spent the first decade of his career in finance holding positions as an equity analyst and portfolio manager before starting his own hedge fund which led him to the firearms industry. This experience, along with a deep background in manufacturing, banking and private equity, has made him a sought-after contributor on numerous boards, discussion groups, media outlets, corporations and community organizations. Currently, Fiorini invests his time with non-profit initiatives and acts as a contributor and management consultant to various firms in the firearms industry. His activities have been reported in such publications as The Wall Street Journal, The New York Times and USA Today.