Navigating the various retirement plan options for a small business owner can be overwhelming. There are many different plans and each plan has their own advantages and disadvantages. Also, business owners need to strike a balance between the benefits provided to themselves and their employees.
What is the goal of their plan? Is a purpose of the plan to attract and retain top talent? Are they offering the plan to provide their employees with incentive to save? Is one of the main reasons for establishing the plan to allow them to save as much money as possible for retirement?
Four of the most popular plan options for small businesses are the:
- Simplified employee pension plan (SEP),
- Savings incentive match plan for employees (SIMPLE),
- Profit-sharing plan with 401(k) option (401(k) plan), and
- Solo 401(k) plan.
Simplified employee pension plan (SEP)
SEPs are one of the easier plans to setup and one of the most cost effective to administer. There are no limits on the number of employees. Three main downsides to a SEP plan are that only the employer can make contributions to the plan, employers are required to make the same contributions at the same percentage to all eligible employees, and there are no vesting provisions. Employees are entitled to the contributions once they have been made to the plan.
Savings incentive match plan for employees (SIMPLE) IRA plan
SIMPLE plans have a few more rules as to which businesses qualify for the plan. There is an employee cap of 100 or fewer employees who have received $5,000 or more in compensation in the preceding year. One benefit of a SIMPLE plan over a SEP plan is that employees can make tax-deferred salary contributions to the plan. Also, these plans are simple to setup and administer. With a SIMPLE plan, the employer must either match each employee’s salary reduction up to 3% or make a non-elective contribution of 2% of an eligible employee’s compensation (up to $275,000 for 2018).
Profit Sharing Plan with 401(k) option plan (401(k) plan)
One of the most popular plans is the 401(k) plan. The plan is a profit sharing plan with a 401(k) feature that allows employees to make pre-tax contributions to the plan. For 2018, participants can make contributions of up to $18,500 ($24,500 if the participant is over age 50). Total contributions (employee and employer) that can be made to a 401(k) are limited to the lesser of:
- 100% of the employee’s compensation, or
- $55,000 (for 2018)
A benefit of the 401(k) plan is that it allows for a vesting schedule for the employer’s contributions. One downside of a 401(k) plan is that it is more complicated and expensive to set up and administer. There is a yearly tax filing requirement, and the plan will generally require a third-party administrator to be involved.
Solo 401(k) plan
If the only employees of a business are the owner and their spouse, the business could qualify for a solo 401(k). The solo 401(k) gives the benefits of a standard 401(k) offered by larger companies but are easier to set up and typically have lower administrative costs. These plans are typically offered and administered by mutual fund and insurance companies.
Below is a comparison of the different retirement plan options:
|SEP||Simple IRA||401(k)||Solo 401(k)|
|Primary Advantage||Simple to setup and maintain; reasonable administrative costs||Simple to setup and maintain; reasonable administrative costs||Allows for larger salary deferrals by employees||Simple to administer; maximizes deduction per year|
|Employer eligibility||Any employer with one or more employees, including self-employed individuals||Any employer with 100 or fewer employees who have received $5,000 or more in compensation in the preceding year||Any employer with one or more employees||Self-employed individual with spouse as only employee|
|Maximum 2018 contribution (per participant)||$55,000 for 2018 or 25% of compensation, whichever is lower||Employee – $12,500 salary reduction contribution; $15,500 if age 50 or over;
Employer – required to make either (1) dollar-for-dollar matching contributions up to 3% of the employee’s compensation or (2) fixed nonelective contribution of 2% of the employee’s compensation (up to $275,000 in 2018)
|Employee – can make elective deferrals of up to $18,500 in 2018, $24,500 if age 50 or over;
Employer – contributions are limited to the smaller of $55,000 (for 2018) or 100% of the employee’s compensation
|Employee – can make elective deferrals of up to $18,500 in 2018, $24,500 in age 50 or over;
Employer – contributions are limited to 25% of the employee’s compensation (earned income is self-employed)
|Employer Contribution Deadline (not Employee Deferrals)||Contribution must be made by the company’s tax filing deadline including extensions||Contribution must be made by the company’s tax filing deadline including extensions||Contribution must be made by the company’s tax filing deadline including extensions||Contribution must be made by the company’s tax filing deadline including extensions|
|Vesting||Contributions vest immediately||Contributions vest immediately||Contributions may vest periodically per plan terms||Contributions vest immediately|
|Admin Costs and annual maintenance fees||Reasonable setup costs; annual custodial fee per participant; no annual IRS filing required.||Reasonable setup costs; annual custodial fee per participant; no annual IRS filing required||Setup costs depend on number of participants; most likely will require annual third-party administrator accounting fees; annual filing with IRS required||Reasonable or no setup costs; annual filing with IRS required.|
When deciding which plan to offer, some of the most important factors to consider are:
- Affordability – the plan needs to make economic sense for the company to set up, fund, and administer.
- Who can contribute – does the plan need to allow contributions from employees? Is there a way to be selective about who can participate?
- Employee turnover/vesting – Does the plan need to allow for vesting? Does the presence of vesting incentivize employee retention?
- Contributions limits – Are the contributions made for the benefit of owners appropriate in comparison to the other employees, given the plan’s objectives?
- Administrative requirements – Does the plan require annual tax filings and a third-party administrator? Will the company be responsible for administration?
Selden Fox is here to help you navigate the different retirement plan options. Contact us with any questions you have.
Nathan E. Sharp, CPA, MST