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Choosing a Retirement Plan for My Small Business

As an employer, you can play an important role in helping your employees save for their retirement.  Most people will need between 70 and 90 percent of their preretirement income to maintain their standard of living in retirement.  By establishing a retirement plan, you can help secure your own retirement and that of your employees.

Aside from the obvious benefit of saving for the future, there are several other key benefits to creating a retirement plan:

  • There are tax advantages to you (the employer) and the employee. Contributions are typically deductible from your taxable income. If your business is not incorporated, you can generally deduct contributions from your personal income. If your business is incorporated, the corporation can deduct the contributions as a business expense. Employee pre-tax contributions reduce an employee’s wages for income tax purposes.  Both employer and employee contributions grow tax deferred until withdrawn.
  • Eligible small employers can claim a tax credit for part of the expense involved in establishing and administering certain retirement plans, up to a maximum of $500 per year.
  • Retirement plans can help you attract and retain qualified employees. Employer plans often allow employees to save their own contributions beyond the limits of individual retirement accounts (“IRAs”). Employer matching contributions, in addition to employee contributions, make the benefit of saving even more attractive.

Types of plans available for small businesses:

Simplified Employee Pension IRA (“SEP IRA”):  If you have a business with variable income and you want more flexibility, a SEP IRA may be for you.  If you are self-employed, you can contribute up to 25% of net earnings from self-employment, up to a maximum of $54,000 in 2017.  If you have employees in years you contribute to the plan, you must contribute the same percentage of income for them as you contribute for yourself.  SEP IRA plans are funded solely by employer contributions, meaning employee contributions are not permitted.  You do not have to contribute every year to a SEP IRA, which is key to its flexibility, but any contributions made on behalf of employees are 100% vested upon contribution.

Savings Incentive Match Plan for Employees (“SIMPLE IRA”):  If you prefer that your employees have the ability to make contributions, you might consider a SIMPLE IRA.  SIMPLE IRAs are only available for businesses with up to 100 employees.  Employees can make annual salary deferral contributions up to $12,500, not to exceed 100% of their compensation.  You as the employer must also contribute to their accounts—you can either match the employees’ contributions dollar for dollar up to 3% of compensation (contributions can be reduced to as little as 1% in any two out of five years) or contribute 2% of each eligible employee’s compensation.  The SIMPLE IRA also allows employees age 50 or older to make catch-up contributions of up to $3,000 in 2017.  Employer contributions on behalf of employees are 100% vested upon contribution.

401(k): The 401(k) is the most popular type of retirement plan in the US. With this plan, both the employer and employee can make contributions. The employer component can include matching contributions up to a certain percentage, nonelective contributions and/or profit-sharing contributions. For 2017, employees can make elective deferrals of up to $18,000. The total contribution limit cannot exceed $54,000. This plan allows a $6,000 catch-up contribution for those over age 50. Additional benefits can include vesting schedules, loan provisions and after-tax Roth contribution options.

SELF-EMPLOYED or SOLO 401(k):  The self employed 401(k) plan has the same benefits and features as the 401(k) plan above, but is specifically designed for solo entrepreneurs. Only the owner and his or her spouse may participate in the plan. This plan offers the largest possible contribution because it recognizes that self-employed people wear two hats—as an employer and as an employee.  As an employer, you can make a profit-sharing contribution of up to 25% of compensation, to a maximum of $54,000 for 2017.  As an employee, you can make elective deferrals of up to $18,000 for 2017.  Total contributions as employer and employee cannot exceed $54,000 for 2017. This plan also allows a $6,000 catch-up contribution for those over age 50. And this plan also can offer loan provisions and after-tax Roth contribution options.

In choosing the plan that works best for you, consider how much flexibility you want in terms of contribution limits and who is going to make contributions.  You also should take into consideration the cost of set up and ongoing administration. The SEP, SIMPLE and Self-Employed 401(k) can be established with relative ease at most brokerage firms with very little, if any, setup and ongoing administration cost.  Neither the SEP or the SIMPLE require annual plan filings with the Internal Revenue Service.  The Self-Employed 401(k) does not have discrimination testing or fling requirements until the plan assets exceed $250,000. The 401(k) typically does require the services of a third party administrator who can set up and administer the plan on an ongoing basis. Their fees are usually based on a flat amount and increase with the number of participants in the plan.

Of course, if none of these plans are right for you, you can always help your employees establish and fund individual retirement accounts, either traditional or Roth. While contribution amounts are more limited, you are still helping your employees save for their future, while offering an added benefit to your overall employment package.  When choosing a plan, consider your priorities and weigh the pros and cons carefully.  Retirement planning decisions you make today can have a tremendous impact on your future and that of your employees.