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It can be difficult for small-business owners to navigate the complexities involved in choosing a good retirement plan. The goal, of course, is to find a plan that serves your and your employees’ interests without introducing prohibitive costs that negatively impact your business’s bottom line.

Fortunately, there are several retirement plan options well-suited to the needs of the small-business owner.

These plans include simplified employee pensions (SEP-IRAs), solo 401(k) plans for the self-employed, and the Simple IRA. Each plan is relatively inexpensive and includes features that make it more or less suitable for different kinds of small businesses.

Simplified Employee Pensions (SEP-IRAs)

If your operation is fairly small and likely to stay that way, the simplified employee pension plan (SEP-IRA) may be right for you. The SEP plan is available to businesses with any number of employees, including the self-employed.

The SEP offers a simple, straightforward way to contribute toward your own and your employees’ retirement without introducing numerous administrative costs. You’ll have to put together a formal written agreement, and you’ll need to provide benefits to all eligible employees, but you won’t need to file an annual Form 5500 with the IRS.

Under a SEP, the employer sets up an individual retirement account (IRA) for each eligible employee, which the employee owns and controls, but only the employer contributes funds. As the employer, you can contribute funds equal to up to 25% of your employee’s compensation or $56,000 (for 2019), whichever number is smaller. Contributions are tax-deductible, and your employees won’t have to pay taxes on the money until they withdraw it.

One of the SEP’s main advantages is that it allows for flexible annual contributions from the employer. You don’t have to contribute to your employees’ accounts each year, which is particularly helpful to businesses that face routine cash-flow problems. But when your company does contribute, it can’t discriminate. All eligible employees must receive contributions based on the same formula, and you can’t leave any eligible employees out.

The Solo 401(k)

If you’re self-employed and want to generate as much retirement savings as possible in a short period of time, or if your income is high enough that you can afford to contribute more, a better plan may be the individual or solo 401(k).

The solo 401(k), also known as the self-employed or individual 401(k), is built on the fact that a self-employed individual is both an employer and an employee. Since any 401(k) plan allows both the employer and employee to contribute to an employee’s retirement account, the solo 401(k) opens potentially lucrative savings possibilities.

In your role as employee, for instance, you can defer up to $19,000 of your pretax income to your retirement account. In your role as employer, you can then make a contribution to the same account of up to 25% of your compensation as an employee (with a combined maximum, at least in 2019, of $56,000). 

But the solo 401(k) also matches the flexibility of the SEP-IRA discussed above. You can contribute anywhere between the maximum amount and nothing at all without penalty, so you can shoot for the maximum in a good year and decrease your contributions if or when your company faces hard times.

You can also start a Roth version of the solo 401(k). The Roth version allows you to contribute after-tax dollars instead of pretax dollars, which means that the money you withdraw at retirement will grow tax-free and won’t get taxed again. If you expect to jump tax brackets at some point down the road, the Roth individual 401(k) might serve you well.

However, once your plan’s assets exceed $250,000, you’ll need to start filing the annual Form 5500 with the IRS. The solo 401(k), moreover, is only available to self-employed individuals who don’t employ anyone besides themselves and a spouse. If your business has other employees, or if you will likely hire additional employees at some point in the future, the solo 401(k) probably won’t work for you. You’ll need to start a SEP-IRA or a Simple IRA instead.

The Simple IRA

The advantage of the SEP-IRA is its simplicity and flexibility. Only the employer contributes to the employee’s retirement account, and the employer isn’t required to contribute each year. But these employer-specific advantages are precisely why the SEP-IRA may not always sit well with your employees, particularly if the company consistently fails to make annual contributions. If your small business has achieved a measure of financial stability, a retirement plan with a mandatory annual business contribution may send a better message.

The Simple IRA is one such plan. It salvages some of the SEP-IRA’s simplicity while allowing both employers and employees to contribute funds. Like the SEP-IRA, a Simple IRA is relatively inexpensive to start and manage. Keep in mind, however, that the Simple IRA is generally for small businesses with 100 or fewer employees that don’t have another retirement plan. If your company has surpassed this number, you might consider looking into a traditional 401(k) plan instead.

If you decide to start a Simple IRA retirement plan, you’ll have two options for how to contribute to your own and your employees’ retirement accounts:

  • match 100% of the employee’s first 3% of deferred compensation (which you can reduce, if need be, to as low as 1% in two out of five years)
  • make an across-the-board 2% contribution to the accounts of all eligible employees (called a non-elective contribution)

The amount an employee can contribute from his or her income, however, tends to go up every few years to track inflation. The maximum employee contribution in 2018, for instance, was $12,500, but this changes to $13,000 in 2019. Like the SEP-IRA, moreover, the Simple IRA adds few administrative responsibilities, and you won’t need to file an annual Form 5500 with the IRS.

Some Final Thoughts

When you’re trying to manage and grow a small business, a retirement plan may seem like an unnecessary distraction—an administrative hassle, at best; at worst, an additional drain to your company’s already razor-thin margins. But a suitable retirement plan can offer a small business numerous long-term benefits that should not be ignored.

Some of these benefits are more tangible (and more obvious) than others. For instance, your business can write off contributions to retirement accounts as a business expense, at least within limits defined by the IRS, and businesses are often eligible for up to three years of tax credits to help offset the costs of starting a new plan. And the money stored away by you and your employees in your retirement accounts typically avoids taxation until withdrawn later in life. Even when it doesn’t, as with the Roth version of the solo 401(k) discussed above, the plan will still offer clear tax advantages.

Less obvious are the effects a good retirement plan can have on the ways others perceive your company, particularly if your company employs individuals other than you and your spouse. In a time when employee retirement plans are practically a staple of every competitive business, lacking one can send mixed signals about your company’s financial and administrative stability, as well as your more general interest in your employees’ quality of life. This message can resonate especially with older employees with little to no retirement savings. Ultimately, without a retirement plan, you may struggle to attract and retain top talent and find yourself at the helm of a less innovative, less productive organization.

The truth is that few of us (including many business owners) have the foresight and financial wherewithal to plan a successful retirement. We all need help, and company retirement plans allow business owners to structure their own retirements or partner with their employees to make intelligent, collective decisions for the benefit of everyone involved.

About the Author(s)

Drake Forester

Drake Forester writes extensively about small business issues and specializes in translating complex legalese into language everyone can understand. His writing has been featured on Fox Small Business, AllBusiness.com, Score.org and many other websites and blogs.

Legal Strategy Officer, Northwest Registered Agent
businessman looking down road to retirement