As a small business owner, both you and your employees need a plan that will provide the income flow needed for a secure retirement. There are many variables involved in choosing the right one. These include the number of employees, business income, age of employees, tax regulations and how much you and your employees plan on contributing to the plan. Your goal is to achieve financial security for both you and your employees, so this decision should not be entered into lightly. There are many retirement plan options available to small businesses, each with their own unique benefits.
SEP (Simplified Employee Pension Plan)
A SEP is one of the easiest and least expensive plans for a small business owner to set up and maintain. Contributions are tax deductible and investment earnings are tax-free. SEP plans cost less to start than traditional IRAs and there is very little documentation required. This plan allows for a contribution of up to 25 percent of an employee's income. You can use this pension plan whether you are a sole proprietor, partnership, or corporation.
An individual 401K plan may be the right choice for you if you are self-employed or own a business with just you and your spouse, and your priority is to save for yourself. The Individual 401(k) has the same benefits of the traditional 401(k) but costs much less and requires little paperwork. An Individual 401(k) plan may also be adopted by a partnership or corporation where the only eligible participants are the business owners. With the Individual 401(k), you can defer up to 100 percent of your W-2 wages, to a maximum of $16,500 ($22,000 if you are 50 or older). In addition, as an employer, you can contribute up to 25% of your eligible wages to the plan, but the total of your salary deferral plus your employer contribution cannot exceed $49,000 ($54,500 if age 50 or older).
A business 401(K) is available to just about any size business. Typically, this plan will be more complex and costly to the employer than a Simple IRA, but does offer more flexibility with options relating to employer contributions and availability of funds (ex: in the area of loans). In addition, the salary deferral limit for a 401(k) is $16,500 ($22,000 if you are 50 or older), compared to the Simple IRA limit of $11,500 ($14,000 if you are 50 or over). Combined with employer contributions, total contributions to an employee’s account can reach $49,000 ($54,500 if age 50 or older).
The Simple IRA is a good option for employers with less than 100 employees. Employees can make salary-deferral contributions of 100% of their W-2 wages, up to $11,500 ($14,000 if age 50+). As the employer, you must make contributions to the plan, but you have (2) choices:
- You may make a contribution of 2% of each eligible employee’s compensation, regardless of what they contribute, or
- Match your employee’s contribution dollar-for-dollar up to 3% of their wages. Subject to certain limitations, the 3% level can be reduced to no lower than 1%.
Your contribution level may change from year to year, but you must inform your employees of the employer contribution level annually. Unlike a 401(k), there cannot be an option in the Simple IRA to permit loans from the account.
Personal Defined Benefit Plan
A personal defined benefit plan may be a good option for you if you are an older small business owner nearing retirement and need to catch up on retirement savings. Higher contribution limits are allowed with this plan than with others. You can target the income level you desire for retirement and save aggressively to reach that goal. Your CPA can adjust your contributions each year to make sure you reach your desired goal.
Profit Sharing Plan
With a profit-sharing plan, you can contribute for yourself and eligible employees. You can choose when and how much you want to contribute to the plan. A profit-sharing plan can be customized as to when, and which employees, are allowed to participate. Unless the plan includes a 401(K) or deferred feature, employee contributions are not allowed. Contributions to the plan are generally not taxed by state or federal government until they are distributed. A profit-sharing plan can be designed to allow employees to take their benefits with them when they leave your employment, thus easing your administrative costs.
Consult with your CPA before making a final decision on a small business retirement plan. He or she will be able to provide you with specific details about each of them – as well as other options that may be available. With the right advice, you will be able to develop a retirement strategy that offers the most advantages to your unique business situation.