Whether you are a sole proprietor or a business with a number of employees, there are a number of small business retirement plan options to choose from. Each has their own pros and cons, and it may be overwhelming to get started with so many different options.
Think of the guide below as your cheat sheet to choosing a great retirement plan. We've outlined the basics of what differentiates one from the other—and where the advantages are. Read on to learn more:
The Solo 401(k) is specifically designed for those businesses that have no full-time employees other than yourself, your spouse and/or a business partner(s). No other employees can participate in the plan.
These plans allow for annual employee contributions of up to $18,500—$24,500 for those 50 or over. Additionally, discretionary company profit sharing contributions can be made each year up to 25% of each participant’s compensation bringing the total contribution limits to $55,000—$61,500 for those 50 and over—for 2018.
Solo 401(k) plans are available to sole proprietors, S-Corps, LLCs and C-Corporations.
Designed to provide greater benefits to business owners and potentially their employees, a SEP-IRA is limited to employer contributions. Which means, as a practical matter, a SEP-IRA can be an expensive proposition if employees are involved; employees must receive the same percentage of compensation contribution that business owners make for themselves.
SEP-IRA contributions are based on up to 25% of compensation with an annual maximum of $55,000 for 2018.
Solo 401(k) versus SEP-IRA
It is common for small business owners to consider both the Solo 401(k) and the SEP-IRA as viable options if they are solo business owners, have a spouse involved in the business, and/or have business partners but not other employees.
Understanding the following details can help you make the best decision for the unique needs of your business and the resources at your disposal:
- Both have minimal paperwork or filing requirements.
- Both can be easily opened, and most custodians and account holders have a wide range of investment choices available to them.
- To contribute to a solo 401(k) for the current year, the plan must be established by December 31. A SEP-IRA can be opened and contributions made for the current year by the company’s—or, if a sole proprietor, the individual’s—tax filing date, including extensions.
- Employee contributions to a solo 401(k) can be up to 100% of their compensation up to the maximums. If their compensation is above maximum, they can make the full contribution to the plan—even in a year when the business’ revenues and profits might be down. With a SEP-IRA, lower business profits may impact the amount they can contribute—even if the owner has the cash on hand.
- Solo 401(k)s allow both participant loans and a Roth version. Neither option is available with a SEP-IRA.
401(k) Plan / Profit Sharing
Small business 401(k) plans allow employees to contribute to their retirement via salary deferrals of $18,500—or $24,500 if they are 50 or over—on an annual basis for 2018. Employers who choose to do so can offer a matching contribution for their employees as well.
Additionally, employers can make a discretionary profit-sharing contribution each year. The amount can range from zero to 25% of employee compensation and may be higher in profitable years for the company—or skipped entirely in years when the company’s results are not as stellar.
In some cases, the plan can be configured in such a way that the bulk of the company contributions are legally skewed toward the owner.
In evaluating small company 401(k) plan providers, it is important to look at the underlying costs of administration and the mutual funds or other investment options offered.
Unfortunately, many small business 401(k)/profit sharing plans include fees which can detract from the amount the owners and employees can save. And that may have implications for the business owner’s responsibilities as a fiduciary to their employees.
A SIMPLE IRA is an employer-sponsored plan much like a 401(k), but with far less burdensome administration rules. It's available to small businesses with 100 or fewer employees that don’t offer any other employer-sponsored retirement plans. Employers must contribute to employee accounts either as a non-elective 2% of compensation contribution or a dollar-for-dollar matching contribution up to a maximum of 3% of the employee’s contribution.
The 3% matching contribution can be temporarily reduced in some instances based upon a specific set of rules and procedures.
While the SIMPLE IRA has some advantages, it does have several drawbacks:
- Contributions are capped at $12,500 for 2018. This limits the amount that a business owner or their employees can save for retirement.
- Catch-up contributions are limited to $3,000 in 2018 for those 50 and over.
- The money in a SIMPLE IRA cannot be rolled over to an IRA or another retirement account if the employee leaves the company unless at least two years has elapsed since the employee’s first contribution to the plan. If done sooner, a steep 25% penalty is applied.
Small businesses can launch a defined benefit pension plan that provides a set or defined benefit for the employee at retirement based on a formula which could include a combination of their overall compensation and years of service.
Though pensions are expensive to maintain—especially for companies with many employees—for companies with stable cash flows and profits, these vehicles can be a great way to ramp up savings.
A cash balance pension is a variation of a pension where the employer credits the employee's account each year based on a set percentage of their compensation and an interest rate that is either fixed or that varies based on a benchmark like the 30-year Treasury. These plans often appeal to older business owners as the rules allow them to defer much larger amounts than a defined contribution plan like a 401(k) with a profit-sharing component.
A company-sponsored retirement plan creates an opportunity for business owners and employees alike to save for retirement with the potential added bonus—depending on the program and state—of tax benefits or asset protection from creditors. In the purest sense, it is a way to build employee loyalty and reward devoted service to your company—while also helping you prepare for your own future.