Small Business Retirement Plans: Why 401(k)s Are The Best Option
If you are looking for the right retirement plan for your small business – congratulations! You have several options. The four most popular types of small business retirement plans are:
- Solo 401(k)
- SEP IRA
- SIMPLE IRA
- Traditional 401(k)
Not so long ago, the first three options were simpler and cheaper alternatives to the traditional 401(k). Each of the three defined benefit plans was easier to set up, and offered tax-deferred growth and pre-tax contributions.
The Solo 401(k), SEP IRA, and SIMPLE IRA are still popular. But a new breed of cloud-based 401(k) providers has put the 401(k) within reach of many more small businesses.
Even if your small business has as few as 25 employees, a 401(k) may be the best retirement plan option for your dynamic, growing enterprise.
Introducing Four Small Business Retirement Plans
The four plan options are all designed for tax-deferred growth of retirement savings.
Each plan is a bit different. And some of the differences could make one or more plan types a deal breaker for your small business. Let’s take a look at each. (For a review of even more types of plans, visit the IRS website.)
#1: Solo 401(k) – Retirement Plan for the Self-Employed
This retirement plan is for self-employed individuals. With no company to sponsor one for them, the Solo 401(k) is a retirement plan for the business owner or partnership going solo.
The business owner can make a contribution as an employee and as a business owner. And total contribution limits are much higher than with a traditional IRA. As with the traditional 401(k), the combined employee and employer contribution limit is $55,000. A $6,000 catch-up contribution is also allowed. An employed spouse is subject to the same limits.
Much like with a 401(k), Solo 401(k) contributions are flexible. Both the employee and the company can make contributions one year and skip the next.
Opening up a Solo 401(k) is akin to opening up a new brokerage account. But once assets reach $250,000 the IRS requires an annual report on the plan. That means completing Form 5500-EZ.
Solo 401(k) key takeaway: this is a plan for the sole proprietor or the owner and spouse.
#2: SEP IRA
The term is short for Simplified Employee Pension Individual Retirement Account. No wonder most people just call them SEP IRAs.
This is unlike a traditional 401(k) in that the employee sets up an IRA to receive contributions. The company then makes contributions to the individual account. Also unlike a 401(k), employees are not allowed to make deferrals. Only employers can contribute to an SEP IRA. But contributions are not mandatory, and if made, are not required every year.
If a company does make contributions, it must contribute the same percentage of compensation to each employee. And even though employees can’t contribute, the contribution limit of $55,000 holds here as well. And with no employee contribution, there is no catch-up provision.
No tax filings are required for a SEP IRA.
SEP IRA key takeaway: Does not allow employees to make contributions. Company alone funds the retirement plan.
#3: SIMPLE IRA
A SIMPLE IRA is a Savings Incentive Match Plan for Employees Individual Retirement Account. For this blog post, let’s keep it SIMPLE.
A SIMPLE IRA is designed for small businesses with 100 or fewer employees. Employee contribution limits are below those of the traditional 401(k). And the catch-up provision is half the $6,000 allowed under a 401(k). A key feature of the SIMPLE IRA is that employer contributions are required. The company has two options. It must make matching contributions of up to 3%, or contribute 2% of each eligible employee’s compensation. (Companies can reduce the 3% match over certain defined periods.)
Setting up a SIMPLE IRA is like setting up a SEP IRA. Employees control their own investments. It is even possible for employees to choose their own financial institution. Loans are not allowed with these plans. No tax filings are required.
Key SIMPLE IRA takeaway: employers must make contributions.
#4: Traditional 401(k)
The 401(k) is big brother to the other three plans. The 401(k) offers a flexible plan design, and the company and employees control their contributions. An investment fiduciary chooses the investments that will be available to participants. The fiduciary also monitors the investments to ensure they remain appropriate.
But 401(k)’s are heavily regulated. And they come with administrative and compliance burdens. For example, there is the annual filing of IRS Form 5500. To ensure benefits are broadly shared, plans must either perform non-discrimination tests or adopt a Safe Harbor plan.
The good news is that small businesses can offer a modern 401(k) and hand off most administrative and compliance burden.
401(k) Key takeaway: Employees and employer have considerable flexibility with plan contributions and plan design.
Contribution limits of SOLO, SEP, SIMPLE, and 401(k) plans
Rules about contributions may determine which plan you choose for your small business. The general rules on contributions for each of the plans are presented below.
- Solo 401(k): $18,500 maximum or 100% of self-employment compensation, whichever is less. A $6,000 catch-up contribution available for employees 50 and older.
- SEP IRA: Salary deferral contributions not allowed.
- SIMPLE IRA: $12,500 maximum or 100% of salary, whichever is less. A $3,000 catch-up provision available for employees 50 and older.
- Traditional 401(k): $18,500 maximum elective deferral or 100% of salary, whichever is less. A $6,000 catch-up contribution available for employees 50 and older.
- Solo 401(k): Employer contributions are not required. Contributions are limited to 20% to 25% of business compensation (depending on the type of business) up to $55,000. For employees 50 and older the limit is $61,000. The limit is the same for a spouse.
- SEP IRA: Employer contributions are not required. But if made, the same percentage must go to all eligible employees. Maximum contribution is 25% of compensation up to a limit of $55,000.
- SIMPLE IRA: Employer contributions are required. The employer has two options. It can either make a matching contribution or contribute to all eligible employees. If it chooses a match, it must match employee contributions dollar-for-dollar up to 3% of compensation. The company can reduce the 3% match to 1% in two out of five years. Under the 3% match there is no employer contribution limit. Under the second option, the business can contribute 2% of compensation to all eligible employees. However, when this option is chosen, the maximum employer contribution per employee is capped at $5,500.
- Traditional 401(k): Employer contributions are not required. Matching or profit sharing contributions limited to 25% of compensation up to $55,000. Total contributions cannot exceed $55,000, or $61,000 for employees 50 and older.
Comparison of Four Small Business Retirement Plan Types
|SEP IRA||Solo 401(k)||SIMPLE IRA||401(k)|
|Designed for:||Self-employed and small business owners||Owners with no employees other than a spouse||Small businesses with 100 employees or fewer||Small to large businesses|
|2018 Employee Contribution Limits||Not allowed||$18,500||$12,500||$18,500|
|2018 Total Contribution Limits||25% of compensation or $55,000||20% or 25% of compensation or $55,000||Employee deferrals plus employer contributions of either 1.) match up to 3% of salary (no limit) or 2.) 2% of compensation regardless of deferrals (max is $5,500)||25% of compensation or $55,000|
|Administrative Notes||No tax filings||Form 5500 EZ at $250,000 in plan assets||No tax filings||Form 5500, Non-discrimination testing, mandatory notices, extensive compliance|
|Key Features||No employee contributions||Limited to single employer (and spouse). Roth option||Mandatory employer contributions||Flexible plan design. Roth option|
New Providers Allow Small Businesses to Offer Big League 401(k)s
The traditional 401(k) is the most flexible of retirement plans discussed here and offers generous contribution limits. One key advantage is the employer’s flexibility. They may choose to regularly provide a specific match. Or they may decide to contribute a different amount each year. Today’s 401(k)s can offer automatic enrollment and automatic escalation. These features can get employees enrolled and saving more each year. The 401(k) allows for higher employee deferrals than the SIMPLE IRA, and the SEP IRA (where they are not even permitted).
The downside to the traditional 401(k) used to be complexity, cost, and sometimes the headaches associated with compliance.
That’s no longer the case. At ForUsAll, we believe plan sponsors should not have to devote tremendous company resources to provide a retirement plan. We can manage everything from the day-to-day operations of your 401(k) to signing the Form 5500. ForUsAll offers proprietary technology and deep compliance experience. That means we can virtually eliminate the work and administrative risk that comes with offering a 401(k). That means you can spend time on your business plan and less on your retirement plan. You can see more about the services ForUsAll can provide here.
On the investment side, ForUsAll can act as your independent advisor and 3(38) fiduciary. That means you can outsource mutual fund selection and fund reviews. We select a fund menu that allows participants to create portfolios to meet their savings and retirement goals. And all at a low cost.
If you are looking for the right retirement plan and like the idea of outsourcing tasks and liability, and want to work with a provider who puts fiduciary responsibilities in writing, give us a call today. Let us estimate your retirement plan expenses on up to three recordkeepers at no cost.