Small Business Retirement Plan Options
If you’re a small business owner, retirement might be the furthest thing from your mind as you manage the everyday details of your business. However, retirement planning is extremely important to your future and the sooner you begin the easier it is to reach your goals.
There are several options for small business owners, but in this article we will focus on the four most common options we see used by our small business clients: The SIMPLE IRA, SEP IRA, solo 401K and Safe-Harbor 401(k).
The SIMPLE IRA:
The Savings Incentive Match Plan for Employees IRA (SIMPLE IRA) works for employers with less than 100 employees who earn at least $5,000 annually. This plan is easy and affordable to set up and maintain, and allows for higher contributions than traditional or ROTH IRAs. For 2015, employees can contribute $12,500 for the year, or $15,500 if age 50 or older. Employers have two contribution options: 1) Match employee elective deferrals dollar for dollar up to 3% of wages (can be reduced to as low as 1% in any two out of five years) or 2) Contribute 2% of wages (up to $260,000) for all employees (including nonparticipants). Contributions by the employer are mandatory, regardless of profitability of the business.
It is important to remember, if you would like to open a SIMPLE IRA account, it needs to be done by October 1st of the current tax year in order to make a tax-free contribution for that tax year. One potential downside is early withdrawal penalties could be as high as 25% of the accounts balance if taken within the first two years of participation in the plan, and 10% thereafter.
The SEP IRA:
The Simplified Employee Pension (SEP IRA) is also easy and affordable to setup and maintain. Unlike the SIMPLE IRA, however, contributions are only made by the employer. Many businesses use this as an incentive tool for employees by correlating the amount of contributions to the profitability of the business.
A SEP IRA is a good choice for business owners who want to make large contributions (up to 20% of net self-employment earnings or 25% of S-corporation owner wages to a maximum limit of $53,000). On the other hand, there are no mandatory contribution requirements, which helps if the business is having a rough year. These plans can be established as late as the due date of the tax return, including extensions if applicable. Also, it can be easily terminated if your business outgrows this type of plan.
Conversely, the drawbacks to a SEP IRA are all employees must be included if they are eligible. Also, the percentage of contributions must be the same for all employees (including the shareholder(s) employees). This can be difficult if the business owner wishes to save significant amounts of their salary for retirement, since they’ll have to also contribute to their employee’s accounts by the same percentage.
The Solo 401(k):
The Solo 401(k) is for a self-employed individual or owner of a small business with no employees (other than a family member). This type of savings plan allows you to contribute to your retirement plan as an employer and as an employee, allowing higher contributions than the SIMPLE IRA and SEP IRA. You can maximize your contributions as an employee up to $18,000 for 2015 ($24,000 if 50 or older), and have your business contribute up to 20% of self-employment earnings (or 25% of S-Corp wages) up to a maximum combined contribution of $53,000 for 2015 (or $59,000 if 50 or older). The total combined contributions are limited to the lessor of 1) 100% of wages or self-employed income or 2) $53,000 ($59,000 if 50 or older). There’s no contribution requirement, so you can contribute whatever you want each year, or nothing at all.
Keep in mind this type of plan is more complex to manage, and consequently more expensive, with an annual reporting requirement once the account exceeds $250,000.
The Safe-Harbor 401(k):
The Safe-Harbor 401(k) typically allows highly compensated employees to contribute more than traditional 401(k) plans. Since a safe-harbor requires a 3% annual contribution to the employee account whether the employee contributes or not the plan is not subject to the limitations on highly compensated employees. As in the Solo 401(k) plan, the fees and reporting requirements are greater than that of the SIMPLE IRA and SEP IRA. The Safe-Harbor 401(k) contribution limits are the same as the Solo 401(k) limits. Sometimes these plans are also coupled with a profit sharing plan to maximize contributions to selected groups of employees.
Other Retirement Plan Options:
There are other retirement plan options which may be better for your business such as a traditional 401(k) plan or a defined benefit plan. Also, most of the retirement plan options above can have a Roth option as well.
Conclusion:
Since there are many variables and retirement plan options we recommend you meet with your CPA and financial advisor to determine which retirement plan is best for your specific situation.
