Small Business Retirement Plans: What to Offer?
posted by Fisher 401(k) April 1, 2019
When you think of a company-sponsored small business retirement plan, what comes to mind? A traditional 401(k) plan—the kind in which your employees contribute tax-deferred money to a retirement account—might be the first thing that pops into your head. But if your small business has 100 employees or fewer, there are options outside of a traditional 401(k) that may better suit the needs of your business and employees.
Let’s take a closer look at two small business retirement plan options that may benefit you and your employees—and how they compare to a traditional 401(k).
Simplified Employee Pension Plan – SEP IRA
SEP IRAs are easy retirement plans to set up, and are best suited for people who are self-employed or small businesses with only a handful of employees. Only employers are allowed to make contributions, which can reduce taxes as a business expense. Those contributions go to a traditional IRA held in the employee’s name, and contributions can be as much as 25% of an employee’s income (or up to $56,000, whichever is less).
- Because it’s IRA-based, it’s cheap to start. There is no recordkeeper or third party administrator to pay, so administration costs are low.
- There is minimal administrative burden to maintaining your plan—including no IRS Form 5500 to fill out, no compliance testing, and no payroll deductions.
- The business owner may put away up to $56,000 per year toward retirement, or up to 25% of their earnings (whichever is less).
- Owners must contribute to their employees’ accounts at the same rate that they contribute to their own. So if a business owner is contributing 20% of their own income, they must also contribute 20% of each employee’s income to their own accounts. Depending on the number of employees a business owner has, this can get expensive.
- Employees aren’t allowed to contribute their own savings to a SEP, as contributions are allowed only by the business owner(s). Therefore, the business owner must fund their employees’ accounts.
Takeaway: Your small business—or anyone with freelance income—can open a SEP IRA. They’re easy and have high contribution limits, and it can be used as a competitive recruiting advantage. However, if you’re looking to save the maximum per year, you’ll have to be prepared to shell out contributions to all of your employees.
Savings Incentive Match Plan for Employees – SIMPLE IRA
SIMPLE IRAs, along with SEP IRAs, are among the easiest retirement plans to set up and run. SIMPLE IRAs have similar benefits to a SEP IRA, with one key difference: Employees can contribute to them. This makes it appealing to employees looking to contribute their own money, and business owners who don’t want to hire someone to run the plan or spend a lot of time dealing with government non-discrimination testing or plan design. Businesses with SIMPLE IRAs do not have vesting schedules for their employees, and aren’t required to report taxes at the plan level—but they are required to match employee contributions.
- Like a SEP IRA, it’s cheap, and there are no recordkeeper or TPA fees.
- No IRS reporting, compliance testing, or other administrative maintenance needed.
- Employees are allowed to contribute.
- Contributions are limited to only $13,000 per person per year; business owners looking to max out their retirement contributions would be limited.
- Owners are required to offer their employees either a 3% matching contribution, or a 2% salary-based contribution. This means that even employees who don’t contribute to their retirement would still receive a contribution equal to 2% of their yearly pay.
- Savings in a SIMPLE IRA account cannot be rolled into another account until the SIMPLE has been established for at least two years.
Takeaway: If you’re looking for an easy-to-run, relatively low-maintenance retirement plan that allows your employees to contribute to their retirement, a SIMPLE IRA might be right for you—particularly if you have a loyal employee base with low turnover.
A Traditional 401(k) Plan
A traditional 401(k) plan—sometimes referred to as a defined contribution plan—is a common retirement plan that many small businesses choose to start. The biggest obstacle is typically cost—but the flexibility of features for a traditional 401(k) is the main reason business owners choose this type of employer-sponsored retirement plan. They’re also great for diversifying tax savings strategies, which is one of the many ways a 401(k) can be designed with unique business needs in mind.
- Business owners may put away up to $56,000 per year toward retirement, or $62,000 for those 50 and older, for a 401(k) with a profit sharing feature. While the individual maximum is $19,000, ($25,000 for those 50 and older) adding a profit sharing feature allows for an additional $37,000 in savings.
- You can design your 401(k) to drive employee retention, employee participation in the plan, pass most compliance testing, expand business tax savings options, and share profits with employees. Features such as safe harbor, profit sharing, or cash balance can be added to make the plan more competitive for attracting high-end talent.
- Tax credits of up to $500 for each of the first three years of the plan are available to business owners to help offset administrative costs.
- Most 401(k) plans will undergo yearly testing by the IRS and/or Department of Labor to make sure that the plan is fair to all employees.
- More partners are required to administer a 401(k), as they are more complex; business owners will need to hire a third party administrator and recordkeeper for their plans, thus making plan administration more costly. However, some 401(k) service providers may offer a representative that helps coordinate those relationships to make life simpler for the business owner.
- You’ll have to set up a plan document for your 401(k), and regularly file paperwork related to it. Depending on who you choose as your service provider, they may share or take on some of your fiduciary responsibilities.
Takeaway: If you’re looking to maximize your tax benefits and take advantage of higher contribution limits ($56,000, or $62,000 for those 50 and older) than a typical IRA ($6,000, or $7,000 for those 50 and older), a 401(k) will allow you to take advantage of many savings features. A 401(k) will be far more flexible than either a SEP or SIMPLE IRA, allowing you to customize your plan to meet the needs of your business.
Regardless of which retirement plan you choose, retirement professionals recommend saving as much as you can, and starting as early as you can. Plus, you’ll be helping your employees save for their retirement—a benefit that many sought-after workers will appreciate.