Retirement Deeper Dive Part 1: Why have a retirement plan?

Compound interest is one way to earn extra money. It is the interest earned on interest.

 Example: You decide to eat out one less time per month and put $50 monthly into retirement savings. This example is based on a 6.5% interest rate (the average in 2022 for retirement accounts).

• You will save $600 in year one ($50 x 12 months). You will also earn $18.20 in interest. The total saved at the end of year one would be $618.20.
• You put $50 per month into retirement savings in year two. The monthly deposits and interest earned at the end of year two are $1,277.81.
• Continue this for 30 years and you will have $18,000 and $37,308.90 in interest. This is a total of $55,308.90!

How can a retirement plan help keep employees?

A retirement plan adds up over time so it can be a great tool for retaining staff. In a Morgan Stanley 2022 survey, 93% of employees consider retirement plans a reason for choosing where to work. Offering a retirement plan can attract new employees in a competitive labor market.

Sole owners also need a retirement plan. Many child care providers have considered leaving the profession for other jobs that offer retirement benefits. Retirement plans can provide benefits to stay in child care and prepare for the future.

 What are business contributions and matches? How do they work?

Business contributions or matches can fund retirement plans. A business can contribute to or match an employee’s contributions to the employee’s retirement plan. Many plans either allow for or require businesses to contribute to the employee’s retirement. Contributions can be a set amount, a percentage of the employee’s pay, or a “match.” A match is when the employer contributes the same amount as the employee, often up to a certain percentage.

 Example: An employer offers to match up to 3% of an employee’s pay to a retirement plan.

• The employee earns $30,000 per year and contributes $900 annually (3%).
• The employer would contribute (match) $900. This increases the total contribution to $1,800. This match is basically free money for the employee!

The money may not be available until the employee is vested. Vesting is the time it takes for the business portion of the retirement account to be fully “owned” by the employee. The amount of time can vary from business to business. Businesses can choose for employees to become vested when hired or require they be employed for a certain amount of time to become fully vested. The maximum time for an employee to become fully vested is six years.

 Example: You have a three-year vesting schedule and make a $600 contribution for an employee in 2022.

• If the employee leaves your business in 2023, they will have 1/3 or $200. The employee is “partially vested.” The rest of the money would be returned to the business.
• If the employee leaves your business in 2024, they will have 2/3 or $400. The employee is still “partially vested.” The rest of the money would be returned to the business.
• If the employee leaves your business at the end of 2025, they will receive the full $600. The employee is now “fully vested” since they have been employed for three years.

 A vesting period can encourage employees to stay at your business longer to access 100% of the employer contributions to their retirement.

How much should I contribute to my employees’ retirement?

Most businesses contribute an average of 4.3% of the employee’s annual salary. There are some things to consider before choosing an amount.

First, check what other child care providers are offering in the area. A retirement contribution is like a form of employee pay. You want to keep up with or beat other businesses in the area. Turnover can be costly. LinkedIn estimates turnover can cost 1.5-2 times an employee’s pay. This includes the time to recruit and hire, overtime hours from other employees to cover shifts, and the time and cost of onboarding. Keep checking other providers in the area on a regular basis to make sure what you are offering is still competitive.

Second, many U.S. employers (if the retirement plan allows it) choose to require matching and vesting. A match means that an employer will contribute only if the employee does. Usually matches are 50% of the employee’s contribution up to a certain amount.

Example: An employer has a 50% match for up to 3% of an employee’s total salary.

• If an employee makes $35,000 and contributes 3% of their salary for retirement ($1,050), the employer will contribute $525.

Employer contributions are mostly vested where possible. In the example above, if the employee had to wait three years to be vested but left after two years, they may get a

portion of the employer contribution (maybe 75% of the $525). Regular contributions and compound interest are incentives for employees to stay with your business.

 How can a retirement plan help save money?

You can keep more of your profit when saving for retirement. Tax benefits and potential credits from the federal government can offer savings for employers and employees.

 Three ways to save are:

1. Contributions your business makes to the plan are deductible. This includes the maintenance cost of the plan, even if it is for you. The amount of business revenue taxed will decrease which also affects your personal income tax return.

2. Retirement plans are tax-favored. The government gives tax benefits to encourage saving.

Some retirement plans use pre-tax money. This is money taken out of your income right away. Pre-tax money isn’t taxed today. The money made in the account over the increased value of the investment will be taxed.

Example: You will not be taxed on the $5,000 you invest in a SEP IRA today. You will be taxed when you retire on the $14,350 you may gain over the next 20 years in investments.

Other retirement plans use post-tax money. This means your money is taxed now, but not the increased value from investing.

Example: You will pay taxes on the $5,000 you invest in a Roth IRA today. You will not be taxed on the $14,350 gain while invested over the next 20 years.

3. Retirement contributions can get tax credits.

The Savers Credit is a non-refundable credit for:

• Adults over the age of 18
• A person who is not a dependent of someone else
• A student

It also gives a credit of up to 50% of retirement contributions (up to $1,000 in credits) if you are:

• Married and have an adjusted gross income of less than $73,000, or
• A head of household making less than $54,750, or
• Single and making less than $36,500.

Remember that adjusted gross income is usually less than total income. Even if your salary is higher than the limit, you still may qualify.

The Retirement Plan Startup Costs Tax Credit is for employers who have retirement plans that include W-2 employees who are not owners. The credit was updated in December 2022.

Some key facts about this credit:

• If a business has 100 or fewer employees, this credit covers up to $5,000 in administrative costs for the first three years of a new 401k, 403b, profit sharing, SEP IRA, or Simple IRA plan.
• Businesses with less than 50 employees can get a credit of up to $1,000 per employee in the first year of the plan for contributions they make for employees who earn less than $100,000.
• This credit continues for three more years but decreases by 25% each year.

Example: You have an employee who makes $32,000 annually. You contribute $1,000 per year to their retirement over five years. The total credit received would be $2,500.

Here are two examples of how these savings can benefit you:

a. Kashuana

Kashuana is a family care business owner and sole proprietor who makes $38,000 per year. She put $2,000 into a SIMPLE retirement account (the plan types will be covered in Part 2 of this guide).

The $2,000 will save her three times over. Here’s how:

• First, she’ll save 15.3% in self-employment tax and 12% in income tax (a total of $546).
• Second, she qualifies for the Saver’s Credit, so she gets a tax credit for 50% of the contribution ($1,000).
• Kashuana has $2,000 in retirement after the money saved and credits. The cost to her was only $454!

b. Estelle

Estelle has a center with 15 employees. She decided to use stimulus money to start a 401k. Her business is an LLC that chose to be treated as an S corporation. Because of this, the profit goes on to her personal tax return which is taxed in the 22% bracket.

Estelle contributed 5% of the salary of each employee ($1,560 per employee) for a total of $23,400. She paid a total of $2,550 for administrative costs. This amount includes the fees and the costs of her time to set up the 401k accounts and for a bookkeeper.

Estelle can save money in three ways:

1. She will get 100% of her administrative costs back ($2,550) since the accounts are new.
2. Since her employees make less than $100,000, she can get up to $1,000 back for her contributions to each employee. This amount equals $15,000.
3. She will save another $5,709 after the deduction for contributions and administrative costs.

Setting up a retirement plan through your business will help you and your employees prepare for a successful retirement, provide additional retention incentives, and help you save money in the long run. To learn more about selecting a retirement plan, see Retirement Part 2: How do I choose the right retirement plan?

Need more help?

You can sign up for one-on-one coaching with our experts at www.childcare.texas.gov. The website also provides free information, resources, and tools related to taxes, finances, staffing, operations, and many more topics.

Additional Resources

Retirement Basics

Employee Benefits

Attract the Best Talent

The Employee Retention Tax Credit

The Families First Coronavirus Response Leave Act

Paying Yourself

 Disclaimer: The information contained here has been prepared by Civitas Strategies and is not intended to constitute legal, tax, or financial advice. The Civitas Strategies team has used reasonable efforts in collecting, preparing, and providing this information, but does not guarantee its accuracy, completeness, adequacy, or currency. The publication and distribution of this information is not intended to create, and receipt does not constitute, an attorney-client or any other advisory relationship. Reproduction of this information is expressly prohibited.

Questions?

If you have any questions, you can reach out to the Texas Workforce Commission Child Care Coaching Team at Coaching@ECEBizCoach.org.