Management Company Series: PEOs and Retirement Plans

Let’s explore how Professional Employer Organizations (PEOs) work, key retirement plan options, and the tax benefits and trade-offs that come with each.

When a small business considers hiring additional employees, several challenges may arise, such as recruiting and hiring, benefits and payroll administration, and compliance assistance. A Professional Employer Organization (PEO) can address these issues effectively. A PEO enters into a joint-employment relationship with an employer by leasing employees to the employer. The scope of services provided by the PEO can be negotiated based on the agreement and contract.

One important aspect to consider when setting up a contract with a PEO is the retirement plan. Utilizing a PEO for retirement plans can help outsource fiduciary liability and reduce administrative costs. However, it is important to note that retirement plans through a PEO may have limitations, fewer options, and less flexibility compared to setting up the plans independently.

Retirement plans are valuable tools for small business owners to reduce taxable income and self-employment tax. Contributions made to the plan for employees are deductible, and sole proprietors can also deduct contributions made for themselves. Below are brief introductions to a few common types of retirement plans:

SEP plans offer a simplified method for making contributions to a retirement plan for both the business owner and employees. This plan is particularly beneficial for self-employed individuals or small-business owners with only a few employees. SEP plans are solely funded by employer contributions, and each eligible employee must receive the same percentage.

SIMPLE Plans are similar to SEPs in that they are easy to set up and inexpensive to maintain. However, they can be funded by both employee deferrals and employer contributions. SIMPLE Plans can be established by self-employed individuals or businesses with 100 or fewer employees. Under this plan, the employer is required to contribute matching or nonelective contributions.

Qualified plans offer more flexibility in designing plans and can increase contributions and deductions in some cases. There are two basic types of qualified plans: defined contribution plans and defined benefit plans, each with its own set of complex rules. A common plan for management company owners is the Self-Employed 401(k), also known as Solo 401(k). This plan is designed for self-employed individuals with no employees other than a spouse, allowing contributions as both the employer and the employee.

Both PEO contracts and retirement plans offer distinct tax advantages and employer responsibilities. It is crucial to thoroughly research and understand these aspects before adopting a written plan.

Authors: Sally Sun, CPA | [email protected] and Amanda McKenna, CPA, Partner and Team Leader, Financial Services Tax | [email protected]