Retirement Plan Options for the Small Business Owner

Running a small business isn't easy! In fact, it's extremely difficult. As an owner, every decision, big or small, seemingly runs through you. Whether it be which payroll company to use or who to hire, each choice can have a lasting impact on your business's success. Choosing the correct retirement plan is no different.

Retirement benefits have become a necessity for potential employees; thus, offering them tends to bring about higher-quality candidates while ensuring current staff retention. They also provide tax incentives for you as an owner while ensuring you achieve your own individual retirement goals. So which plan is right for you?

Plan Type Options

The most common small business retirement plans include the Simplified Employee Pension (SEP), the Savings Incentive Match Plan for Employees (SIMPLE IRA), and the 401(k). Each brings about different administrative responsibilities, contribution limits, and contributory allowances. All of this makes deciding on your business's best plan a massive undertaking. To help simplify the decision-making process, let's review the characteristics of each.

SEP IRA

The SEP IRA is an employer-only funded plan meaning your employees cannot contribute portions of their salary. These plans are popular in the small business realm because they are easy to establish, low maintenance, and require no employer tax filing.

For participation purposes, an employee must be 21 years of age, have worked for the company in at least 3 of the proceeding 5 years, and expected to earn at least $600 in compensation. As the employer, you have the discretion, but NOT the requirement, to contribute up to 25% of your employees' compensation annually up to IRS annual limits ($57,000 in 2020). However, the contribution rate for all employees must be equal.

The discretionary contribution provision allows for flexibility during cash-strapped years. Consistent with traditional IRAs, distributions are taxed as income, and penalties may apply to withdrawals before age 59 ½.

SIMPLE IRA

Another popular plan type is the SIMPLE IRA. Very little administration is involved, and while no employer tax filings are required, you must provide certain annual notifications to your employees. Participation in the plan requires that the employee has earned at least $5,000 in the prior two years and is expected to earn $5,000 in the current year.

The contributory allowances are expanded a bit, by comparison to that of the SEP IRA. Your employees can contribute by salary deferral of up to $13,500 or $16,500 for employees over 50 (in 2020).

As an employer, you are given the option of making matching or 'non-elective' contributions. Matching contributions are limited dollar-for-dollar up to 3%. However, the IRS allows this match to be reduced (to either 1% or 2%) but in no more than 2 out of every 5 years. If you choose the non-elective route, you will be required to contribute 2% for each employee regardless of whether they are participating in the plan or not.

For employees looking to take distributions, they are similar to IRAs with one caveat: any withdrawals occurring within 2 years of employee participation in the plan increases the early distribution penalty from 10% to 25%.

401(k)

The 401(k) offers the most flexibility from an employer standpoint. However, administratively speaking, there is a bit more complexity with these plan types than the plans above. The IRS requires you to file Form 5500 annually (not needed if you operate a solo 401K with fewer than $250,000 in assets) to ensure the plan is adhering to guidelines and standards set forth by the regulatory bodies.

Third-party administrators are generally required to oversee the plan (not required if a solo 401(k)), which adds an additional expense to the overall cost.

From a contribution perspective, the 401(k) offers employees the ability to defer up to $19,500, or $26,000 if over 50 years old (in 2020), while typically providing some form of match. Employers have the flexibility to offer a straight match of 100% up to a certain percentage threshold or a partial matching scheme where they may contribute, for example, 50% of what you contribute up to 6% of an employee's salary. Employers can also incorporate a profit-sharing component to the plan allowing them to make additional, discretionary contributions.

Distributions are typically restricted while employed, although loans and hardship withdrawals can be incorporated into the plan structure.

Summary

Each of the retirement plans highlighted above are available for any entity type, but SIMPLE IRAs require you have no more than 100 employees at the time of plan establishment. They all allow for the deductibility of any employer contributions you make on the employees' behalf.

Vesting is immediate in the SEP and SIMPLE IRAs, while the employer contributions in 401(k)s tend to have a graded vesting schedule. Employer contributions in 401k plans become vested over time at specific intervals.

While many of the characteristics tend to overlap, there are many differences between each of the plan types. Enlisting your financial planner's services is recommended. Choosing the correct plan can allow for a prosperous business while achieving your own retirement objectives.

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