A Guide to Small-Business Retirement Plans
Small-business owners considering retirement plans face a plethora of options. Some shy away from making a decision for fear of making an incorrect one. But it doesn’t need to be complicated. There are a number of choices for small-business retirement plans, but they generally narrow down to just a couple, and your objectives can quickly steer you to the most appropriate plan.
Why Should I Have a Retirement Plan?
The decision to put a small-business retirement plan in place is usually driven by one or more of three factors.
One is tax benefits. Plans generally allow business owners to use pre-tax business money to fund contributions on their behalf. Most allow for pre-tax employee contributions, including the owner. A business owner can potentially lower both their business taxes and personal taxes, depending on the form of business and plan selected.
Retirement savings plans are frequently seen as essential for attracting and retaining quality employees. Your prospective employees are very aware that many employers offer the option to put pre-tax dollars away for their retirement — and that they can get company matching contributions. All else being equal, this can sway employees toward the business where they can do the best for themselves.
Small-business retirement plans are also important for assuring both your and your employees’ futures and retirements. For your employees, your retirement plan may be the only thing they have to build for their own retirement. We know Social Security won’t be enough. Your employees need this, whether they know it or not — as do you.
As an owner, you know nothing is guaranteed. The future may be bright, but it’s also uncertain.
Investing into a retirement plan helps insulate the owner from the financial effects of a future business downturn.
More importantly for many owners, it provides diversification against what is generally by far their largest asset — the business. Besides, more money always opens up more options.
Decision Factors and Types of Small-Business Retirement Plans
A small-business owner should focus on two factors in choosing a retirement plan: cost and complexity; and how you want to direct the benefits toward the owner(s) and nonowner employees.
Cost and complexity narrow the list to just a few options unless you have a pretty big small business. But for businesses with fewer than 100 total employees, there will really just be three or four small-business retirement plans to consider.
The under-100-employee crowd should consider a SEP IRA, SIMPLE IRA, SIMPLE 401(k), and self-employed 401(k). You can consider other options, but those are more commonly used for businesses with more than 100 employees. Let’s focus first on the small-business retirement plans for those with fewer than 100 employees.
1. Simplified Employee Pension (SEP) IRA
Any size of business can use this type of plan. It has some of the lowest costs and is one of the easiest plans to implement. Its big advantage is that it works great for businesses that are cyclical or tend to have good years and less good years.
The downside is that SEP IRAs (or individual retirement accounts) only allow for employer contributions. Employees can’t contribute. This limits the amount employees can put away themselves and denies them the tax advantage of a pre-tax plan through work.
Here are the key points:
- Any size of company can use this plan
- Easy to set up
- No annual filing requirements
- Only allows for employer contributions — no employee contributions.
- Maximum contribution of 25 percent of each employee’s salary or wages
- Maximum contribution of $55,000 for any one employee (2018)
- Must do the same percentage for all employees
- Employees immediately vested
- Can do different contribution percentages each year
2. Savings Incentive Match Plan for Employees (SIMPLE) IRA
While the SIMPLE IRA is technically available to any size of business, it’s generally used by organizations with fewer than 100 employees. The company can choose to contribute either through a matching contribution or through a set two-percent contribution to all eligible employees.
The set contribution method allows the owner to provide some retirement benefit for all eligible employees.
The plan also allows for employees to contribute to their own retirements and to make pre-tax contributions.
Here are the key points:
- Any size of company can use this plan (but generally for those with fewer than 100 employees)
- Easy to set up
- No annual filing requirements
- Allows for employee contributions
- The employer must contribute, either as matching (100 percent of the first three percent contributed) or level (two percent)
- Employees are immediately vested
- Maximum deferral for employees is $12,500 for 2018. An additional $3,000 catch-up contribution is allowed for those age 50 and older.
3. SIMPLE 401(k)
A SIMPLE 401(k) is very similar to a SIMPLE IRA, with the added feature of allowing for participant loans. Both SEP IRAs and SIMPLE IRAs, as a form of IRA, can’t allow for participant loans. A SIMPLE 401(k) is a low-cost plan option that allows this feature.
The other major difference from the SIMPLE IRA is that the 401(k) has slightly higher contribution requirements for the employer. The primary reason to consider a SIMPLE 401(k) is to have a loan provision as part of your retirement plan.
4. Self-Employed 401(k)
If you think this is referring to a solopreneur, you’re very close. It’s really for a business in which all employees have an ownership interest. One nonowner, and you’re out.
The big plus is that this plan allows you to take care of the owners well — very well, in fact. It’s for self-employed and other forms of business, as long as there are no nonowner employees. This plan is also referred to as a solo 401(k) or individual 401(k) — all the same thing.
Here are the key points:
- Only for businesses where all employees are owners
- Immediate vesting
- Employer contributions maximum of 25 percent of salary or wages up to $55,000 (2018)
- Employee elective deferrals up to $18,500 per year (2018) plus an additional $6,000 catch-up contribution for those age 55 or older.
- Maximum total contribution of $55,000 per employee for employee and employer contributions combined.
Other Types of Small-Business Retirement Plans
You do have other options, but they will cost you significantly more. If you have more than 100 employees, then they are worth considering. But if you have five, 10, or even 50 employees, you probably don’t need to consider a costly and complex retirement plan. Once you have grown to be a big small business, there may be good reasons to think about moving to one of these plans.
- A profit-sharing plan allows for a company to select an amount of profit, or none, to divide between employees based on a sharing formula. This is generally based on salary or wages. If you have a profit-sharing plan, you must file a form 5500C annually with the IRS.
- A defined benefit plan is a form of pension. This is unlike the more common defined-contribution type of retirement plan. Its primary advantage is that you can provide employees with a pension in retirement — a stream of income they can’t outlive. But it’s more costly to administer, and you must file a form 5500C annually with the IRS.
- A money purchase plan is similar to a profit-sharing plan except that instead of a dollar amount of profit being split amongst the employees, you establish a percentage of their salary or wages to contribute into this retirement plan. It is a lot like a 401(k) without employee contributions. You must file a form 5500C annually with the IRS.
- A 401(k) is the one plan most people are familiar with and the one most business owners assume they want. But it’s more costly to set up and administer than any of the three basic plans geared toward businesses with fewer than 100 employees. Plus, you have to file the 5500C annually.
Putting It All Together
A big advantage of these “other” small-business retirement plans is that, unlike the first three discussed, you can use them in combination. You can have a 401(k) and a profit-sharing plan, or any other combination. If you have a larger small business, you can mix and match to achieve your specific objectives for yourself and for your employees.
For a business with over 100 employees, you have a more complex problem. It’s probably a good idea to sit down with a retirement-plan expert (or even interview a couple of experts) and design an appropriate strategy to best meet your long-term objectives.
For businesses with fewer than 100 employees, it’s really a question of looking at the basics. If you have nonowner employees, you probably should consider a SEP or SIMPLE plan. Both are low cost and quite straightforward.
The SEP allows you to not contribute in lean years. The SIMPLE plans have the big advantage of allowing for employee contributions. But you have to contribute whether your year was lean or fat. It’s really that easy.
If you have fewer than 100 employees, choose from the short list of small-business retirement plans based on what is best for you and your business. Make the decision and put your efforts back into doing what you do best, so you’ll have the more complex problem a few years down the road. Then you simply stop doing one plan and start the next. But your expert will guide you through all that.
And don’t forget to take care of your own retirement. Use tools like Blooom to check up on your personal plan and make sure that you’re on the right track and still getting the best bang for your buck.