Small Business Retirement Plan Options
401(k) plan options can be expensive to set up and maintain for small business owners. Fortunately, there are other excellent options that allow business owners to save in a tax-efficient way for retirement: a Savings Incentive Match Plan for Employees (SIMPLE) plan, a Simplified Employee Pension (SEP) plan, and a Solo 401 (k).
If your company has more W-2 employees than just you and your spouse, you may want to consider either a SIMPLE IRA or a SEP-IRA. The plans have similarities and a few differences that must be considered when deciding between the two. Knowing the details of each type can help you decide which is the best choice for you, or which to offer your employees if you own a small business.
The SIMPLE IRA enables employees and employers to contribute to Traditional IRAs. The plan is more cost-effective for a small company (typically 100 or fewer employees) to set up than a 401(k), which requires both set-up and ongoing administrative costs.
All contributions must be invested in the IRA account. Contributions are not subject to federal income tax withholding. Contributions can be invested in stocks, mutual funds, and other similar types of investments. Investment options depend on the choices provided by the financial company maintaining the account.
Employers have two options when it comes to “matching”: 2% of each employee’s salary per year, dollar-for-dollar matching up to 3% of the employee’s salary.
This plan is easy and inexpensive to set up and maintain but comes with downsides - Inflexible contributions and lower contributions limits than other retirement plans.
Simplified Employee Pension (SEP) plans allow employers to save money in retirement accounts for themselves and their employees. They are much more cost efficient than traditional retirement plans and allow for a contribution of up to 25% of each employee’s pay.
SEPs generally require that company owners make allocations proportional to employees’ salaries. As a result, all the contributions for the employees will be the same percentage of salary. Employees can start contributing after working three years at the company and must make at least $650 per year. Annual contribution limits are higher than standard IRAs, and those contributions are vested right away.
To provide tax-efficient retirement saving options to business owners, the IRS allows the solo 401(k), or a one-participant 401(k), which shares many aspects of an employer-sponsored plan. To be eligible for a solo 401(k), the business owner and their spouse must be the only two W-2 employees of the firm.
Contributions fall into these categories:
1) Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
– $20,500 in 2022 or $27,000 in 2022 for those age 50 and older.
2) Employer nonelective contributions up to:
– As the employer, you can contribute additional profit-sharing funds of up to 25% of your compensation or net self-employment income—i.e., your net profit less half your self-employment tax and the plan contributions you made for yourself.
– The limit on compensation used to factor in your contribution is $305,000 this year.
Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $61,000 this year. The one exemption to a solo 401(k) is your spouse – they can contribute too if they work in the business.
The Bottom Line
Small business owners may not have the budget to set up a 401(k) plan for themselves and their workers. However, if they want a way to save for retirement, there are a few options. Owners can choose between a SIMPLE IRA or SEP-IRA. Both plans provide an alternative and more affordable method to encourage retirement savings.
Need help setting up one of these plans for your business? Please give us a call at (717) 317-9006 or send an e-mail to firstname.lastname@example.org