Retirement Plan Types: 401(k) vs SEP IRA, SIMPLE IRA, and Solo 401(k)
So you’re thinking about investing in a retirement plan for your small business? Great idea! You’ll have the opportunity to grow your retirement nest egg with tax deferred savings, and your contributions can reduce taxable income.
But if you are reading this post, you already know there are several retirement plan types available. Which one is right for you? That all depends on the characteristics of your business and what you want from your retirement plan.
For example, do you employ 100 or fewer workers? Or do you run the company by yourself, or perhaps with a spouse? Would the company retirement plan be considered a recruiting and retention tool, or are tax deferrals a key objective? Does your business generate steady income, or does it vary widely from year to year? Once you can answer these questions you are well down the road to choosing the type of retirement plan that is best for you.
Here Are The 4 Most Popular Retirement Plan Types
- Solo 401(k)
- SEP IRA
- SIMPLE IRA
- Traditional 401(k)
In this blog post, we’ll address each of these in turn We’ve also included a handy table – so you can compare the four approaches side-by-side.
Read on to learn which plan type is right or you!
This retirement plan type was designed to be a simple and cost effective solution for the small business owner with no employees. Note, however, that a spouse can be included in the plan. There is little administration involved. However, the Form 5500-EZ form must be filed once the assets reach $250,000.
Contribution limits are generous under the Solo 401(k), allowing for the same maximum tax deferrals as the traditional 401(k). The business owner is allowed to make both an employee and company contribution to the plan. The employee contribution is limited to $18,500 for 2018. Those 50 and over can contribute an additional $6,000. The company can contribute up to 25% of salary or $55,000. So total contributions are limited to $55,000 ($61,000 for those 50 and over). And if a spouse contributes to the business, a family can defer twice the amount.
These plans are flexible as contributions are not mandatory. They can be made whenever profits permit.
Speaking of flexibility, IRS rules allow loans under a Solo 401(k). That’s a handy feature because accessing your funds prior to reaching 59 ½ is not easy. That requires a “trigger event” like a disability or plan termination.
The term SEP IRA is short for Simplified Employee Pension Individual Retirement Arrangement.
We’ll stick with SEP.
The plan is designed for small business owners and allows for flexible contributions. A key difference between the SEP and the other plans discussed here is that a SEP allows contributions from employers only. With no employee contributions and no mandatory employer contributions, the plan is similar to a profit sharing plan. However, an employer has considerable flexibility in structuring contribution levels under a profit sharing plan. Under a SEP IRA, companies must contribute the same percentage to each worker.
The maximum SEP IRA contribution is 25% of compensation or $55,000 for 2018. Because employee contributions are prohibited, there are no catch up provisions for those 50 and over. Also note that with the company responsible for all contributions, the company alone will benefit from the tax deductions. Loans are not available under a SEP IRA, but employees can take withdrawals anytime – but they are subject to a 10% early penalty if taken before age 59 ½. Employees are always 100% vested in a SEP IRA.
A SEP IRA is simple to administer and no tax filings are required. When comparing a SEP IRA to Solo 401(k), it’s important to know that business owners can make larger retirement contributions to a Solo 401(k) for a given level of compensation. That’s due to the employees’ ability to make contributions to a Solo 401(k).
This term is short for “Savings Incentive Match Plan for Employees Individual Retirement Account.” We’ll keep it SIMPLE. These plans are limited to 100 or fewer employees, so if your company will soon pass that benchmark, this may not be the plan for you. Also know that employees who earn as little as $5,000 must be allowed to participate in the plan.
Employee contributions to a SIMPLE IRA are limited to $12,500, with a $3,000 catch up provision. The SIMPLE IRA is the only plan in this group with mandatory employer contributions. The business must either make a 2% contribution to all employees, or make a 100% match up to 3% on each employee contribution.
If the company goes the 2% route, the employer contribution is limited to $5,500. There are no limits on the 3% matching option. But it would take a salary of well over $1 million for the combined $12,500 employee contribution and a 3% company match to result in the $55,000 maximum available under the Solo 401(k) or traditional 401(k) plan. Given the contribution arrangement, in a typical SIMPLE IRA the employees will fund the bulk of plan assets.
While employer contributions are mandatory, there is some flexibility. The 3% company match can be reduced to 1% in two years out of a five year period.
The IRS permits loans with SIMPLE IRAs, and employees can take distributions before 59 ½. But they will incur the 10% early withdrawal penalty if they do so.
The SIMPLE IRA is simple to administer and requires no tax filings. This retirement plan type is not subject to non-discrimination tests, but you should be aware that employees are immediately vested in all contributions.
The full blown 401(k) provides considerable flexibility when it comes to plan design, but administration and compliance can be complex. After all, there is Form 5500 to fill out and non-discrimination tests to perform.
The traditional 401(k) offers higher total contribution limits than either the SEP IRA or SIMPLE IRA. Employer matching with a 401(k) is flexible as long as the plan is not discriminatory.
Borrowing is allowed with a 401(k). The plan sponsor decides whether or not to allow borrowing, and has some flexibility with 401(k) loan policies
Four Retirement Plan Types Side-By-Side
|SEP IRA||Self-Employed (Solo) 401(k)||Simple IRA||401(k)|
|Designed for:||Self-employed and small business owners||Business owners with no employees other than spouse||Businesses with 100 employees or fewer||Small to large businesses|
|2018 Employee Contribution Limits||Does not allow employee contributions||$18,500||$12,500||$18,500|
|2018 Employer Contribution Limits||25% of compensation or $55,000||25% of compensation or $55,000||Match up to 3% of salary without limit. Employer must match 2% regardless of deferrals (max is $5,500)||25% of compensation or $55,000|
|2018 Total Contribution Limits||25% of compensation or $55,000||$55,000||$18,000 when making 2% non-elective contributions. There is no employer contribution limit on the 3% match||Lesser of 100% of total pay or $55k|
|Catch up provision||None||$6,000||$3,000||$6,000|
|Key features||Flexible funding requirements||Form 5500 filing required when assets are greater than $250,000||Mandatory company contributions||Flexible plan design, high contribution limits|
Is a 401(k) right for your small business?
As a small business owner researching retirement plan types, you may think the traditional 401(k) is too expensive and complicated. But at ForUsAll, our goal is to make 401(k)s readily accessible for small to mid-size businesses. We specialize in crafting low cost retirement plans by finding the right fund lineup and recordkeeper. At ForUsAll we handle both the 401(k) investment and administration responsibilities. That means we take on the workload and reduce the liability associated with offering a top notch 401(k).
Talk to us today and let us estimate your all-in costs and explain how we can take administration, compliance, and considerable liability off your plate.