Retirement Plan Options
There are a variety of retirement plan options available for small business owners and self-employed folks. Each one has its own set of rules. Which option someone picks, and how a particular plan is utilized, can make a big difference in retirement savings. The key is to find the plan that is right for you, and to take advantage of the savings and tax features as much as you can. Retirement plans generally allow for tax-deferred growth of contributions and investment returns (tax free growth for Roth-type plans).
You will also want to clearly define your goals before choosing a plan. For example, do you want:
To maximize the amount you can save for your own retirement?
A plan funded by employer contributions? Employee contributions? Both?
A plan that allows you and your employees to make pretax and/or Roth (after-tax) contributions?
The flexibility to skip employer contributions in some years?
A plan with the lowest costs? Easiest administration?
Here is a summary of the major retirement plans available to small businesses the self-employed:
SEP IRA – Allows you to set up an IRA (a “SEP-IRA”) for yourself and each of your eligible employees. You can contribute a uniform percentage of pay for each employee, although you don’t have to make contributions every year, offering some flexibility with varying business conditions. SEP plans provide for employer contributions only. Contributions for 2014 are limited to the lesser of 25% of pay or $52,000 for each eligible employee. Most employers, including those who are self-employed, can establish a SEP.
SEPs have low start-up and operating costs and can be established using an easy two-page form.
Caveat – if you start a SEP IRA as a self-employed person (e.g., S Corp. or LLC owner, or sole proprietor) then later hire employees, you must make contributions for all eligible employees (age 21 or older, employed by you for at least 3 of the last 5 years), as well as yourself…because the money you put into a SEP counts as an “employer” contribution.
SIMPLE IRA – Available to employers with 100 or fewer employees. Employees can elect to make pretax contributions in 2014 of up to $12,000 ($14,500 if age 50 or older). Employers much either match your employees’ contributions dollar for dollar – up to 3% of each employee’s compensation – or make a fixed contribution of 2% of compensation for each eligible employee.
SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs are set up for each eligible employee. A financial institution can do much of the paperwork.
401(k) – The 401(k) plan has become a hugely popular retirement savings vehicle for small businesses and the self-employed. Employees can make pretax and/or Roth (after-tax) contributions in 2014 of up to $17,500 ($23,000 if age 50 or older). Employers can also make contributions – either matching (typically up to a specified percentage of employee pay) or discretionary profit-sharing contributions. Combined employee and employer contributions can’t exceed the lesser of $52,000 (plus an additional $5,500 if age 50 or older) or 100% of eligible employee compensation.
Note that unless a 401(k) plan is a “safe harbor” variety (involving specified, fully-vested percentages of employee pay contributed by employers), somewhat complicated discrimination testing is required each year.
Note: – “Solo” 401(k) plans are available for the self-employed. However, any employees (if eligible) later hired by the self-employed person must be allowed to participate in a 401(k) plan set up under the self-employed person’s/small business owner’s business (similar to SEP-IRA caveat noted above).
Profit-sharing plan – Typically, only employers contribute to a qualified profit-sharing plan. Contributions are discretionary – there is usually no set amount you (as employer) need to contribute each year, and you have the flexibility to contribute nothing at all in a given year if you so choose (although your contributions must be nondiscriminatory, and “substantial and recurring”). The plan must contain a formula for determining how your contributions are allocated amongst plan participants, and a separate account is established for each participant. Contributions for 2014 can’t exceed the lesser of $52,000 or 100% of employee compensation.
Some varieties of profit-sharing plans can be structured to favor older or highly compensated employees; however, this approach can involve complicated calculations and may require actuarial consulting (though typically less expensive and more flexible than a defined benefit plan).
Defined benefit plans – Qualified retirement plans that guarantee employees a specified level of benefits at retirement (for example, an annual benefit equal to 30% of final average pay). In 2014, a defined benefit plan can provide an annual benefit of up to $210,000 (or 100% of pay if less). The services of an actuary are generally required, and these types of plans are generally too costly and complex for most small businesses. However, defined benefit plans can be attractive to businesses that have a small group of highly compensated owners who are seeking to contribute as much money as possible on a tax-deferred basis.
I hope you find this information to be helpful. Feel free to forward to anyone who may benefit. Please contact me with any questions, or if you would like to discuss/would like assistance with any personal financial planning topics such as cash flow/budgeting, health care, taxes, insurance, investing, college/retirement planning, estate planning.
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