For small business owners and solo entrepreneurs, planning for retirement can often take a backseat to day-to-day operations. However, establishing a solid retirement plan is essential for both your future and that of your employees. With various options available, finding the right retirement plan can enhance employee satisfaction while helping to ensure your financial security. Each plan comes with benefits and limitations and this article will help guide you to the right plan for you and your business.
Most retirement plans available are defined contribution plans where plan participants or the employer (or both) elect to contribute a certain amount. A defined benefit plan, the other type of retirement plan, is more like a traditional pension. Defined benefit plans are generally much more expensive for the employer so this article will focus only on defined contribution plans. Defined contribution plans may be IRA-based, like SEP and SIMPLE IRAs, or not, like a 401(k) plan.
IRA-based plans
IRA-based plans are usually easier to run due to fewer IRS reporting requirements and have less associated costs to the employer. Since these are IRA-based, employees can generally contribute at least the maximum Traditional IRA contribution for the year. Employees can access the balance at any time, but may pay a penalty for early withdrawals prior to age 59.5.
These IRA-based plans can also be used by one-person companies and 1099 employees (independent contractors) in addition to more traditional company structures.
SEP IRA Plans
A SEP IRA plan allows the employer to make the bulk of contributions to participants’ accounts. Employees are only allowed to make a contribution up to the traditional IRA contribution limit for the year. The employer decides to contribute a percentage of each employee’s compensation, which must be the same percentage for all.
This plan works well for entrepreneurs with no employees because they can choose to contribute up to 25% of their own compensation or $69K (in 2024), whichever is lower. This plan also works for business owners who may want to contribute in some years but not others as the plan allows you to change the employer contribution rate each year.
This plan can be used by any business, no matter the size.
SIMPLE IRA Plans
A SIMPLE IRA plan allows both employees and employers to make contributions to participants’ accounts. Employees can contribute up to $16K (in 2024) plus an additional $3,500 for any employee age 50 or older. These employee contributions can now be either traditional pre-tax or Roth (post-tax) contributions.
Employers can choose from two contribution options. Contributions can be either a matching contribution of 100% of first 3% of compensation or a flat 2% of compensation for each eligible employee.
This plan is only available for businesses with 100 or fewer employees.
Non IRA-based plans
Most people are aware of traditional 401(k) plans, which are the most common type of non IRA-based retirement plan. A profit sharing plan is a less common type of non IRA retirement plan. Non IRA-based retirement plans usually allow employees to contribute more through salary deferral and also require more work to run.
401(k) Plans
A company of any size can open a 401(k), even a company of one. This plan allows employees to contribute up to $23K ($30,500 for those 50 or older) in salary deferral contributions in 2024. The employer can also, but is not required to, contribute to each 401(k) as long as the combined employer/employee contributions do not exceed 100% of compensation or $69K.
This plan allows business owners to save more for retirement than they could with most IRA-based plans, making it a powerful option for small business owners looking to maximize their retirement savings.
401(k) plans have stringent rules about paperwork and testing for participation. If you have employees, a 401(k) plan may require you to make company contributions for all employees. This plan may work best for companies with enough overhead to pay for a plan administrator who will file the required paperwork for you.
Employers can also offer a Roth option in a 401(k) plan, giving you and your employees the option to choose between traditional and Roth contributions.
Profit-Sharing Plans
Profit-sharing plans are another non IRA-based option that can provide flexibility in contributions. Unlike a traditional 401(k), where contributions are typically made through salary deferral, profit-sharing plans allow employers to make contributions based on the company's profitability. Employers can choose to contribute a percentage of profits, which can vary from year to year.
Profit-sharing plans also allow employees to receive additional contributions beyond their own salary deferrals, further enhancing their retirement savings potential. However, these plans can be more complex to administer and may involve higher administrative costs.
Establishing a retirement plan can provide significant benefits for both owners and employees. With the variety of options available, it is essential to carefully evaluate the features, benefits, and limitations of each type of plan. Consulting with a financial advisor can help ensure you select the best option for your business needs and retirement goals.
