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Small Business Retirement Plans: Which One Is Right For You?
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Working for yourself has its perks, but an employer-provided retirement plan isn’t one of them. You’re on your own to start saving, but there are several types of small business retirement plans you could set up for yourself and your employees, from the easy to more complicated.
The right plan for you depends on your business entity, the number of employees you have (if any), who contributes and how much, as well as the tax implications at contribution and distribution time. We’ll discuss five of the top retirement plan options for business owners and the regulations associated with each.
- Why start a small business retirement plan?
- Top retirement plans by business type
- 5 retirement plan options for small business owners
- How to set up your small business retirement plan
Why start a small business retirement plan?
Setting up a retirement plan can benefit you, your business and any employees that work for the company. You and your workers would be able to set aside a portion of earnings that can grow on a tax-deferred basis. Your contributions as a business owner may be tax deductible, and you may even be able to claim a tax credit for the costs of starting certain retirement plans.
Top retirement plans by business type
Here’s a quick small business retirement plan comparison for three common choices for small business owners. You could also take a short online quiz developed by the Department of Labor, or check out the IRS small business retirement plans list. We’ll talk about these plans and others in greater detail, below.
|Type||Best for||Contribution limits||Key feature|
|SEP IRA||Self-employed||Up to:
||Simple setup and maintenance. Little administrative paperwork.|
|SIMPLE IRA||Larger companies where employer and employee contribute||Employees may contribute up to:
||Little administrative paperwork.|
|Solo 401(k)||Mom and pop businesses||Employees could contribute up to $19,500 annually. With an employer contribution, totals could be as high as $57,000 for 2020.||High contribution limits.|
5 retirement plan options for small business owners
1. Simplified Employee Pension plan (SEP IRA)
A SEP allows employers to contribute to traditional individual retirement accounts, or IRAs. Businesses of any size, including sole proprietors, can set up a SEP. A traditional IRA allows funds to grow tax-free until withdrawn in retirement. Contributions to traditional IRAs may also be deductible on your tax return. You can make contributions for 2019 until April 15, 2020.
Employer role: Only employers can contribute a percentage of each employee’s salary under a SEP plan. Employers aren’t required to contribute every year but if you do, it must be the same percentage for all eligible employees, an amount you would set.
Employee role: Employees are immediately 100% vested and maintain ownership of all SEP IRA money.
Best for: Business owners with or without employees could benefit from a SEP-IRA plan. If you are using a SEP as a self-employed individual, you must use a special rule to calculate retirement plan contributions for yourself.
The business’ contributions to the account would generally be tax deductible. You could deduct the contributions you made for your employees or calculate deductions as a self-employed individual:
- The deductible portion of your self-employment tax, which can be found on IRS Form 1040.
- The amount of your own retirement plan contribution, which is also on IRS Form 1040.
Get started: One of the best things about a SEP IRA is its straightforward setup — fill out Form 5305-SEP. If you can’t fill out the form, you may instead complete a prototype SEP plan with a mutual fund, bank or other financial institution. Once you fill out the appropriate paperwork, there aren’t any annual filing requirements with the IRS for employers.
2. Savings Incentive Match Plan for Employees (SIMPLE IRA)
Like a SEP plan, a SIMPLE plan allows employers to set aside retirement money in an IRA. Small businesses with as many as 100 employees can offer a SIMPLE IRA. Employer contributions are required each year and employees can contribute as well. Similar to a SEP IRA, 2019 contributions to a SIMPLE IRA can be made until April 15, 2020.
Employer role: You must contribute in one of two ways: match an employee’s contribution dollar for dollar or as a percentage of each employee’s salary regardless of the employee’s contribution. When offering a SIMPLE IRA plan, a business cannot have any other retirement plan in place.
Employee role: Employees are immediately fully vested in SIMPLE IRA funds. An advantage of the SIMPLE plan over the SEP is that employees are allowed to contribute to the plan and take advantage of catch-up contributions if they’re 50 or older: $16,000 for 2019 and $16,500 for 2020.
Best for: Small business owners with fewer than 100 employees or self-employed individuals could use a SIMPLE IRA if they do not have any other retirement account. Employer contributions are required each year but may be tax deductible.
If you plan to use a SIMPLE plan as a self-employed individual, you could contribute up to $13,500 of your net earnings plus a fixed 2% contribution or a 3% match. You’d need to calculate your net earnings the same way you would for a SEP IRA.
Get started: Set up a SIMPLE IRA by completing Form 5305-SIMPLE. If you are working with a financial institution, you would need to file Form 5304-SIMPLE instead. Or, you can complete a prototype SIMPLE IRA plan with a mutual fund, bank or financial institution.
3. Solo 401(k)
A one-participant 401(k) plan is a traditional 401(k) plan for business owners without employees, other than their spouse. The advantage of this plan is that you get to wear two hats: employer and employee.
Employee role: Wearing your employee hat, you could contribute a portion of tax-deferred income, up to $19,500 for 2020 and more if you’re 50 or older, an additional annual contribution up to $6,500 for 2020.
Employer role: Your business may contribute additional funds, up to 25% of compensation. As we’ve mentioned earlier, that means making a special computation to calculate your maximum contribution amount. Compensation would be defined as net earnings after deducting one-half of self-employment tax and contributions for themselves.
Best for: A solo 401(k) would be best for solopreneurs or mom-and-pop businesses as it offers higher contribution limits than some of the previously discussed retirement plans, and allows businesses owned by couples to effectively double your contributions as a family.
Get started: No IRS form is required to establish a 401(k), but you may need to file Form 5500 annually if your plan assets exceed $250,000. You must also create a written document outlining how you expect to operate the 401(k) plan, including a record keeping system. You must also notify all employees who are eligible to participate.
4. Traditional 401(k)
With 55 million participants, 401(k) plans are widely recognized and largely give workers and employers flexibility. One downside might be that you will probably need to rely on a financial institution or employee benefit adviser to help you set up and maintain this type of retirement plan.
Employers may have discretion in whether they contribute and which employees are allowed to participate in the plan. However, you may also be bound by rules that call for annual nondiscrimination testing and naming a trustee to protect plan assets. Employers can deduct from their taxes the contributions that the company makes to employees’ accounts.
Employees can put money into an account through pre-tax payroll deductions, up to the $26,000 limit we discussed earlier. Together, with their employer, contributions up to 100% of compensation or $57,000 for 2020, whichever is less, are allowed.
5. SIMPLE 401(k)
Similar to a SIMPLE IRA, a SIMPLE 401(k) is available to businesses with no more than 100 employees. Employer contributions to a SIMPLE 401(k) are required and must be fully vested, giving employees immediate access to all funds. You cannot offer any other retirement plan if you offer a SIMPLE 401(k).
How to set up your small business retirement plan
In some cases, it’s possible to do much of the work of setting up a retirement plan for you and your employees on your own. But, you will still need to decide where to set it up. Here are a few examples of financial institutions that can host your retirement savings plan — and even run it, if you choose. We include the potential costs of establishing and maintaining an account.
TD Ameritrade is a broker and financial asset manager that offers several retirement accounts. The TD Ameritrade SIMPLE IRA has no maintenance or account fees and must be established before Oct. 1. TD Ameritrade’s SEP IRA and solo 401(k) also do not have maintenance fees, but both must be set up and funded before the employer’s tax return due date. You may owe brokerage or commission fees depending on the services you get.
Schwab small business retirement plans encompass solo 401(k), SEP IRA and SIMPLE IRA plans, among other options. Schwab is a brokerage and financial services company and doesn’t require a minimum deposit or fee to open or maintain business 401(k) plans, SEP-IRA, SIMPLE IRA and other business retirement plans. However, you could owe brokerage commissions or fund expenses.
Small business retirement plans from Vanguard, an investment management company, include SEP-IRA, SIMPLE IRA and individual 401(k) plans. Vanguard charges a $20 annual fee for SEP-IRA accounts with less than $10,000, but the fee could be waived based on your circumstances. For SIMPLE IRA accounts, Vanguard charges a $25 yearly fee that may be waived in certain instances. Vanguard’s individual 401(k) plans come with a $20 annual fee that may be waived.
No matter which plan or provider you choose to begin saving for retirement as a small business owner, you stand to benefit from tax savings and peace of mind that you’ve taken care of your financial future.