Small business owners who want to offer their employees a retirement account have multiple options. However, there are pros and cons to each investment vehicle, and before choosing one, you should review the alternatives carefully. All small business retirement accounts fit into one of three categories: Individual Retirement Accounts (IRA), Defined Contribution Plans and Defined Benefit Plans.
In short, IRAs are best for independent contractors or small businesses. Defined contribution plans including 401ks as well as profit-sharing plans are great for small to medium-size businesses, while defined benefit plans that pay participants a certain amount after retirement are ideal for mid to large companies or small companies who want to compete with larger companies for attracting quality staff. Here’s a closer look at specific plans:
Small Business Retirement Plan Options: Types of Retirement Vehicles
Simplified Employee Pension or SEP
As the name indicates, Simplified Employee Pension (SEP) plans are easy to set up and maintain. Designed for employers with one or more employees, these IRA-classified plans only accept employer contributions, meaning employees cannot contribute. You can contribute up to 25% of your employee’s compensation up to $53,000 per year, and you can modify the amount you add from year to year. Employees cannot take loans from these accounts, and contributions are fully vested.
Savings Incentive Match Plan for Employees or SIMPLE
Another IRA retirement vehicle for small business, SIMPLE plans are for employers with 100 or fewer employees. Setting up a SIMPLE IRA plan involves submitting Form 5304-SIMPLE or 5305-SIMPLE to the IRS, but after that, there is no annual filing requirement, and in most cases, the financial institution involved takes care of the paperwork.
Employees can contribute up to $12,500 per year and an additional $3,000 if they are over the age of 50. Employers contribute 2% of each eligible employee’s compensation, or they can match employee contributions at 100% up to 3% of the employee’s wages. Participants cannot take loans from SIMPLE accounts, but they can make early withdrawals with tax penalties.
Traditional 401k plans can be used by companies with one or more employers, but due to their complexity, they are often reserved for relatively large companies. In 2018, employees can contribute up to $18,500 per year to 401k plans and up to $24,500 if they are over the age of 50. The combined total of employee and employer contributions cannot exceed the greater of $53,000 or 100% of compensation. The challenging part of traditional 401k’s is that employers have to submit documents on an annual basis to ensure they are not discriminating between high and low wage earners, or management and rank-and-file employees. Employees can access restricted loans from these accounts as well.
Roth 401ks are comparable to traditional 401ks regarding contribution limits and reporting requirements. The main difference is for your employees. While their contributions for traditional 401ks are taken from pre-tax funds, their contributions for Roth 401k contributions come from post-tax dollars. However, some employers like to offer both options so employees can make the decision that works best for them.
Safe Harbor 401(k)
Also available for employers with one or more employee, Safe Harbor 401k’s offer the same savings benefit to your employees as traditional 401ks, meaning they can build up their nest egg with pre-tax contributions. However, these plans are designed to be easier to administer than traditional 401ks. The main difference is that you don’t have to submit to anti-discrimination testing each year. However, employers must make specified matching contributions that are the same for every employee or a 3% contribution to all participants. Employees have the equal contributions limits on this retirement vehicle as they do on traditional and Roth 401ks.
Profit sharing plans are plans where you, the employer, make all the contributions. The amount you contribute is up to your discretion, but you can add the lesser of $53,000 or 100% of your employee’s compensation. Profit sharing plans don’t have a set model, so you need to work with an employee benefit advisor to set up a program. Additionally, employees don’t contribute to these plans so you may want to have an alternative option in case your employees want to make their contributions.
Defined Benefit Plan
While the above options all fit into the individual retirement account and defined contribution categories, defined benefit plans are a category unto themselves. Similar to traditional pension plans, this retirement plan option for small businesses allows the employer to create a plan that provides a fixed, pre-established benefit for employees. Setting up these plans requires the help of an actuary, and an enrolled actuary needs to sign a disclosure form each year that you submit to the IRS.
If you opt for a defined benefit plan, you must offer it to all employees over the age of 21 who work at least 1,000 hours per year. However, you can modify the projected benefit based on each employee’s salary, job responsibilities, and tenure, and as of 2016, annual benefits can be up to the greater of $210,000 or the average of the employee’s last three years of pay.
A benefit plan helps your business attract talent, and it’s a great way to reward employees for quality work. Setting up a retirement plan can seem daunting, but with the right assistance, it’s relatively easy to set up a plan. When choosing a plan, think carefully about how you want to foster your employee’s retirement goals, how much you want to spend on outside consultants or financial advisers, and the amount of paperwork you are willing to do. Luckily, some plans can work for almost any company, regardless of your size, budget, and objectives.
Small Business Retirement Plan Options Comparison Matrix
|Plan||Business Size||Contributors||Contribution Limits||Employee Loans||Complexity|
|SEP||1 or more employees||Employers||25% of compensation up to $53,000 per year||No||Simple|
|SIMPLE||100 or fewer employees||Employers and employees||Employees may contribute up to $12,500 per year and an additional $3,000 per year if over 50; employers may contribute 2% of employee compensation or do a 100% match up to 3% of employee wages||No||Simple|
|Traditional 401k||1 or more employees||Employers and employees||Employees may contribute up to $18,500 or up to $24,500 if over the age of 50; combined employer and employee contributions must not exceed the greater of $53,000 or 100% of compensation||Yes||Advanced|
|Roth 401k||1 or more employees||Employers and employees||same as traditional 401k||Yes||Advanced|
|Safe Harbor 401k||1 or more employees||Employers and employees||same as traditional 401k, but employers must contribute 3% of every employee’s salary or match contributions at the same rate for every participant||Yes||Moderate|
|Profit Sharing||1 or more employees||Employers||lesser of $53,000 or 100% of employee compensation||Yes||Advanced|
|Defined Benefit Plan||1 or more employees||Employers||limits defined by an enrolled actuary||Yes||Advanced|
What small business retirement plan options did you choose? How is that working for you?
Disclaimer: The article Small Business Retirement Plan Options is for information only. Please consult your tax, legal, and benefits consultants for more update to information and appropriateness for your situation.