Retirement plans give small business owners a couple different opportunities. They can be a great way to attract and retain talent. And, they can play a part in the owner’s personal retirement and tax strategies. Small business owners have multiple options when considering a retirement plan that best fits their situation. Each option has advantages and disadvantages, including costs and contribution limits.
Below is a summary of retirement plans/options available to small business owners:
|SIMPLE IRA||SEP IRA||SIMPLE 401(k)||SOLO 401(k)||IRA|
|Admin Costs/Employee (Annually)||$20-$50||$20-$50||$60-$100||$60-$100||$20-$50|
|Who Contributes?||EE & ER||ER Only||EE & ER||ER Only||EE Only|
|Contribution Limits (2018)||$12,500 (EE) & 3% Salary (ER)||25% Salary up to $55,000||$12,500 (EE) & 3% Salary (ER)||$18,500 (EE) & 25% Salary (ER)||$5,500|
|Catch-up Contribution (50 and over)||$3,000||$3,000||$6,000||$1,000|
|Filing Requirements||None||None||Form 5500||Form 5500-SF||None|
Benefits to offering retirement plans:
- Tax Savings– As a small business owner, you are eligible for up to a $500 tax credit the first year after you start your 401(k) plans for your employees (IRAs aren’t eligible for this credit). Matching contributions are tax deductible for any retirement plan.
- Employee Ownership– Employees can take their retirement money with them when they leave your business.
- Attract Talent– Offering retirement plans is a huge recruiting draw to attract and keep employees.
- Simplicity– Retirement plans, in general, are easy to set up and maintain from an administrative standpoint, and they don’t require the business owner much time maintaining them.
- Owner’s Retirement– Business owners can contribute to their personal retirement accounts which builds retirement funds while allowing for tax planning opportunities.
Disadvantages to offering retirement plans:
- Admin Fees– The average administrative cost per year is $60-$100 per employee for a 401(k) plan, and $20-$50 per employee for IRAs. Additional fees occur often.
- Employer Contributions– Many small business owners often don’t see the benefit in contributing to an employee’s retirement account, and don’t understand how to build retirement contributions into an overall compensation package.
A SIMPLE IRA is a great option for small businesses with under 100 employees. It allows both employees and employers to make tax deductible contributions. It’s also one of the easiest retirement plans to set up, as it has no IRS filing requirements and minimal service fees.
Both the employer and the employee contributes. Contributions are mandatory for employer, but elective for employee.
Employees can contribute up to $12,500 in 2018. All employees aged 50 or over are allowed to contribute an additional $3,000, bringing their total to $15,500. Employers can contribute up to 3% of an employee’s salary (including bonuses, commission and all other compensation).
Matching Requirements– Employers are given two contribution options
- Match employee contributions on a dollar-for-dollar basis up to 3% of their annual pay. If an employee does not contribute, there is no matching requirement.
- Contribute to all employee accounts (whether or not they choose to contribute) an amount of 2% of their annual pay.
Filing Requirements– No annual filing requirement with IRS
SIMPLE IRAs are the easiest way to offer your employees a “real” retirement plan- one where employees contribute money and you match their contributions. Unlike 401(k)s, there’s no filing or testing requirements by the IRS, which makes SIMPLE IRAs a lot easier to set up and manage.
Another key perk to the SIMPLE IRA is that the business owner can be the administrator. Simply create employee accounts, talk with employees to determine their deposit amounts, choose how much to match, and then link your payroll service to the account provider.
The main drawback to a SIMPLE IRA is that employers can’t contribute all that much (up to 3% of an employee’s salary- so $1,500 for an employee that earns $50,000 a year). Also, you have to offer the plan to all employees who earn over $5,000/year, regardless of their length of employment or their part-time vs. full-time status.
SEP IRAs are one of the easiest and most flexible options for small business owners who want to start a retirement account for themselves. SEP IRAs let you contribute up to 25% of the employee’s annual compensation, or up to $54,000, whichever is lower. There’s no minimum contribution requirement, meaning you can change it from year to year, and even take a year off. Although SEP IRAs can technically be used at a small business with employees, they’re not a particularly strong option. This is because SEP IRAs are employer-funded only. There is no way for employees to contribute to their own retirement funds. This is what makes SEP IRAs a good option for self-employed business owners.
Employers can contribute up to 25% of an employee’s total annual compensation or $54,000, whichever is lower. For a self-employed person, the contribution limit is actually lower than that. It is more like 17% of net profits. This is because one-half of the self-employment tax and the contribution itself has to be factored in as an expense before calculating the 25% contribution.
SEP IRAs are one of the more flexible plans in terms of employer contributions. You can choose to contribute whatever percentage of salary/profits you like (below 25%). This percentage can change from year to year, depending on your profitability. If you do have other employees at your business, however, bear in mind that all eligible employees must receive the same percentage.
Reporting Requirements– No filing requirement with the IRS.
The key advantage to a SEP IRA is that you can contribute whatever amount you feel comfortable from year to year. Unlike a SIMPLE IRA, you are never committed to a given percentage. Likewise, the higher limits of a SEP IRA makes it an attractive choice for higher-paid self-employed individuals.
SEP IRAs don’t work well for small businesses with employees. the reason is that employees cannot contribute to their own account.
SIMPLE 401(k) and SOLO 401(k)
While traditional 401(k)s are typically seen at larger businesses, there are other options in the SIMPLE 401(k) and the SOLO (individual) 401(k) that are far more suitable for small businesses. consider one of these plans if you want the flexibility and higher contribution limits of a 401(k) without the high administrative cost and hassle.
Employer and employees
SIMPLE 401(k) Plan
this plan is available to small businesses with 100 or fewer employees. contribution limits are the same as SIMPLE IRAs ($12,500 for employees with $3,000 option for catch-up contributions), and employers have the same matching requirements of up to 3% of the employee’s annual salary.
- SIMPLE 401(k)s allow employees to take out loans against their savings.
- no discrimination and top-heavy testing.
- Immediate Vesting- Employer contributions are 100% vested when made.
- Age requirement- Employees must be 21+ to participate in a SIMPLE 401(k) plan.
- SIMPLE 401(k)s require a Form 5500 be filed annually with the IRS.
- Lower contribution limits
This type of plan is available to sole proprietors or partners who have no employees. It enables business owners to save for retirement with the flexibility, perks, and higher contribution limits of a 401(k) (up to $54,000 per year).
- Higher contribution limits
- Individual 401(k)s allow business owners to take out loans against their savings.
- Simplified administrative process- Form 5500- SF must be filed annually with IRS for accounts over $250K in assets
- Limited investment options due to low demand for SOLO 401(k) plans
- Adding employees causes more complexity and administration
Traditional IRA and Roth IRA
These are not group retirement plans, but rather an option for employees and self-employed individuals who want to set up a retirement account on their own. These retirement accounts give the employer an opportunity to give guidance to employees on retirement planning. Also, this option gives self-employed individuals with multiple ventures the ability to contribute income from multiple sources.
Traditional IRA contributions are tax deductible with retirement distributions being 100% subject to tax. Roth IRA contributions are not tax deductible, but retirement distributions are 100% tax free.
The maximum contribution for a Traditional or Roth IRA is $5,500 for 2018. employees who are 50+ can contribute an additional $1,000, for an overall limit of $6,500. Roth IRA contributions are phased out for MFJ taxpayers with income between $186K and $196K. Likewise, the deductibility of Traditional IRA contributions are phased out for MFJ taxpayers with income between $99K and $119K ($186K and $196K if not covered by an employer provided retirement plan).
N/A. IRAs are funded exclusively by employees, so there’s no matching from employers.
Reporting Requirements– No filing requirements with the IRS.
Easiest of all retirement programs to set up- there’s essentially no administrative cost. Portability can also be a major advantage. Employers can offer guidance to employees in planning for retirement.
Contribution limits are very low compared to other small business retirement plan options. Employers cannot make contributions at all.
Written by: Josh Wells, CPA