Most employers want to help their employees save for retirement, but many think their business is too small for a retirement plan, or they can’t afford it, or they don’t have the time to manage a plan. Some business owners even say their employees don’t want a retirement plan. But there are multiple options for retirement plans that aren’t expensive or complex and that can benefit the business and the owner:
- Owners can save for their own retirement with tax-deductible contributions and tax-deferred investment growth.
- The business can take a tax deduction for contributions made to the plan.
- If the business has at least one employee, tax credits are available for the first 3 years of plan start-up expenses.
- The business is better equipped to attract employees in a competitive job market.
The three most common retirement plans for small businesses are the SEP IRA plan, SIMPLE IRA plan, and Individual(k) plan. If you own a business and want to save for retirement, you’ll want to understand the benefits and features of each plan type so you can pick the best one for your business.
Simplified Employee Pension (SEP) IRA Plan
A SEP plan is a retirement plan available to any size business, with or without employees. A SEP plan can be established with almost any IRA custodian by signing a short, simple document. This plan document contains checkboxes you can select to apply certain requirements your employees must meet to be eligible to receive a contribution. You can require them to be up to 21 years old, to have worked for you in up to 3 of the past 5 years, and to be earning at least $650 from your business in the current year. Contributions are discretionary from year to year, so you are never forced to contribute.
But when you choose to contribute, you must contribute the same percentage of salary or set dollar amount to each eligible employee's Traditional IRA, including your own. The maximum contribution limit for 2022 per person is $61,000, or 25% of compensation, whichever is less.
SEP IRA Plan PROS: Easy and inexpensive to establish and maintain; Contributions are flexible; High contribution limit; Employees manage their own accounts and investments
SEEP IRA Plan CONS: No salary deferral option for employees; Employer must contribute equally for all eligible employees
Savings Incentive Match Plan for Employees (SIMPLE) IRA Plan
The SIMPLE IRA plan is designed exclusively for employers with 100 or fewer employees who earned $5,000 or more during the current year. It is like a 401(k) plan but with fewer administrative requirements in exchange for lower contribution limits. Plan documents are easy to complete and allow employers to require employees to earn up to $5,000 for the current year and/or up to $5,000 in the preceding 1 or 2 years to be eligible to participate in the plan. Eligible employees may elect to defer a portion of their salary into their SIMPLE IRA – up to $14,000 for 2022, plus $3,000 for employees ages 50 and older.
The business must make either an annual contribution equal to 2% of salary to each eligible employee’s SIMPLE IRA, or a matching contribution up to 3% of compensation for each employee making salary deferrals. SIMPLE IRA plans generally must be established by October 1 for the plan to be effective for that year.
SIMPLE IRA Plan PROS: Easy and inexpensive to establish and maintain; Employees can save through payroll deduction; Employees manage their own accounts and investments; No nondiscrimination requirements as with a traditional 401(k) plan
SIMPLE IRA Plan CONS: Employers must contribute each year; Employees must receive plan notices and an opportunity to change their deferral elections each year; Contribution limits are lower than a 401(k) plan
Individual(k) Plan
The Individual(k) plan is a 401(k) plan that is only available to business owners (and spouses) with no employees. It must be established with a plan document, and contributions are made to a plan trust, rather than an IRA. The business owner can make annual contributions equal to that of a 401(k) plan though. For 2022, the salary deferral limit is $20,500, plus $6,000 for business owners ages 50 and older.
The business can also make a profit sharing contribution of up 25% of eligible compensation. Total contributions, excluding catch-up contributions, cannot exceed $61,000 per owner for 2022. Because there are no employees, there are no administrative or nondiscrimination testing requirements, no fiduciary liability, and no employee notices to prepare.
401(k) Plan PROS: Business owners can make pre-tax and/or Roth salary deferrals, a catch-up contribution when eligible, and a tax-deductible profit sharing contribution; High contribution limits; Loans are permitted from the plan
401(k) Plan CONS: A triggering event (e.g., age 59 ½, disability, plan termination) is required to take a distribution from the plan
Which retirement plan is best?
The best retirement plan for your business will depend on several factors, including whether you have employees and your budget. Here are a few general considerations for each plan type.
- SEP IRA plans have high contribution limits and don’t require contributions from year to year, providing flexibility for businesses with fluctuating profits.
- A SIMPLE IRA plan can be good for small business owners who want to offer a robust retirement plan to their employees but don't want the administrative burdens of a 401(k) plan.
- For sole proprietors with no employees, an Individual 401(k) offers the highest contribution limit and allows business owners to max out their retirement contributions, make Roth contributions, and take loans from the plan.
Establish a retirement plan for your business and take advantage of years of tax-deductible contributions, compounding interest, and tax-deferred growth to help you – and your employees – achieve a more comfortable retirement.