Small Business Retirement Plans
The creation of the Simplified Employee Pension (SEP) IRA, Savings Incentive Match Plan for Employees (SIMPLE) IRA, Solo 401(k), and traditional 401(k) provides small businesses and self-employed individuals with various options to establish retirement plans. These plans offer tax advantages and flexibility, making it easier for business owners and employees to save for retirement.
As qualified retirement plans, SEP IRAs, SIMPLE IRAs, Solo 401(k)s, and 401(k)s enjoy the same tax treatment as other retirement accounts. Contributions made by employers and employees are tax-deductible or made on a pre-tax basis, and the funds grow tax-deferred. However, early withdrawals before age 59 ½ may be subject to penalties, depending on the plan type and specific circumstances.
Like all defined contribution plans, the future retirement benefit depends on contribution amounts, the duration of accumulation, and the investment returns. At the time of distribution, withdrawals are taxed as ordinary income, with 401(k) plans offering specific tax treatment options, such as potential eligibility for 10-year averaging under certain conditions.
Simplified Employee Pension (SEP)
A SEP IRA is easy to set up and administer. Each employee establishes their own SEP IRA, into which the employer makes contributions. Although employer contributions are not mandatory every year, when made, they must be allocated to all eligible employees (those over age 21, including part-time workers) based on up to 25% of covered compensation.
Employees manage their own SEP IRAs and can invest in various options such as mutual funds, money market funds, or fixed investments. Funds are always 100% vested and accessible (subject to an early withdrawal penalty). Employees with SEP IRAs can also contribute to their own traditional or Roth IRAs, subject to income limitations.
For employers, the primary responsibility is making contributions by the tax filing deadline. There is no ongoing administration or forfeiture provision to manage.
SIMPLE IRA
A SIMPLE IRA allows employees to establish their own IRA accounts and make tax-deductible contributions. Employees who earn at least $5,000 in any two prior years and in the current year are eligible to participate. The maximum contribution limit is $14,000 or 100% of compensation, whichever is less.
Employee funds are 100% vested, and in addition to the standard early withdrawal penalty of 10%, withdrawals within the first two years of participation may incur a 25% penalty unless exceptions apply.
Employers must match employee contributions up to 3% of their elective deferral or contribute 2% of all employees’ compensation, regardless of whether they contribute.
Solo 401(k)
A Solo 401(k) is designed for self-employed individuals and business owners with no employees (except a spouse). It offers higher contribution limits than SEP IRAs and SIMPLE IRAs. Business owners can contribute both as an employer and an employee. The total contribution limit consists of elective deferrals (up to $20,500) and employer profit-sharing contributions (up to 25% of compensation), with a combined maximum limit of $61,000.
Solo 401(k) plans can allow Roth contributions and loans, providing additional flexibility. While they require more administrative work than SEP or SIMPLE IRAs, they offer greater tax-advantaged savings potential.
Traditional 401(k)
A traditional 401(k) is a well-known employer-sponsored retirement plan that allows employees to defer a portion of their salary on a pre-tax basis. Employers can choose to match contributions and may implement vesting schedules. 401(k) plans are subject to ERISA regulations, requiring compliance with reporting and testing requirements to ensure fairness and non-discrimination.
Employers may also establish a SIMPLE 401(k), which is structured similarly to the SIMPLE IRA but with stricter eligibility requirements that could reduce the employer’s matching obligation. However, SIMPLE 401(k) plans are subject to the same ERISA reporting rules as traditional 401(k)s, potentially increasing administrative costs.
For additional information on small business retirement plans, contact us today.
1 Contributions are limited to 25% of an employee's compensation or $61,000 for 2022.
2 $14,000 is the current maximum and the amount is indexed for inflation.
3 An employer may make less than the 3% contribution for two years out of five year period but it cannot be less than 1%.
