Perhaps your business began as a one (wo)man shop and you were successful enough to expand, or maybe you had employees from the get-go. Either way, one of your small business owner ‘hats’ is to provide a plan for both you and your employees’ retirements, while also doing what’s in the best interest of the company.
A few of your options are the same as if you were going it alone in solopreneurship, but the list of options to choose from does increase, meaning some additional research and consideration is prudent.
As noted in part II on solopreneurship, a Simplified Employee Pension (SEP) IRA is essentially a means of establishing a Traditional IRA for each employee. In your case, as the small business owner, this means setting one up for yourself and each of your full-time employees. The SEP IRA is simple and administratively more cost effective than a 401k plan and it potentially has much higher limits than a Traditional IRA, depending on income.
With a SEP IRA, only you as the employer can contribute to the plan, and you must contribute equally (by percentage of compensation) for all eligible employees in the plan. Because the SEP IRA rules are different, as the employer you’re allowed to contribute up to 25% of compensation, up to the IRS defined contribution limits. Also, an important note when considering this option is your employees are 100% vested in all SEP IRA money.
A Savings Incentive Match Plan for Employees (SIMPLE) IRA plan is available to small businesses with 100 or fewer employees. Assuming your small business meets that criteria, you may consider this as an option. Under this plan you have the option to provide an employer match up to 3% of employee compensation, OR you can opt to do a 2% non-elective contribution, meaning you as the employer must contribute 2% of employee compensation, regardless of each employee’s contribution to the plan. There are some exceptions that can be made on the contribution limits but they’re beyond the scope of this article, so I recommend consulting the IRS website for specifics if this is the plan you’re looking to select.
While this plan is simple to set up and is cost effective for small businesses you should make sure it aligns with your business plan. The employer contributions are inflexible, and it has lower contribution limits than some of your other options.
A SIMPLE 401k plan can be thought of as a combination of the SIMPLE IRA discussed above, and a 401k plan as described below. It is like a SIMPLE IRA because it’s a plan for businesses with 100 or fewer employees and the employer must make either the 3% match, or the 2% non-elective contribution described above. This type of plan is also not subject to the non-discrimination rules like a regular 401k plan.
With this plan, all employees are fully vested in all contributions and the administration is comparatively easy unless you want the added flexibility of participant loans and hardship withdrawals. The contribution limits also differ from SIMPLE IRAs and 401ks, so you’ll want to align the plan with your business and retirement goals. In my 20+ years of being a financial advisor, I can’t recall a small business opting to provide a SIMPLE 401k, so I’d venture a guess that these are rare for a reason.
The almighty 401k plan – it’s common vernacular in most people’s workplace. Even if their work doesn’t provide one, they’ve heard of it and they know generally how it works. That familiarity isn’t a benefit to be overlooked – part of helping people prepare for retirement is educating them and getting them comfortable with the plan. With 401k plans, much of that work is already done for you with many employees’ existing understanding.
401k plans provide more flexibility in your contributions as an employer, they have increased contributions compared to SEP and SIMPLE plans (check the IRS limits for specific values), and as stated above, they’re more common in a typical employee vocabulary. Many record keepers of 401k plans also offer well designed websites and mobile apps which help with employee education and overall effectiveness of the plan. As you probably guessed, with all these perks comes some added expense in the form of administrative costs.
Defined Benefit Plan
Although it’s not as intuitive as it once was, a defined benefit plan’s structure is in its name: it provides a fixed, pre-established (aka ‘defined’) benefit plan for the employee in retirement. However, this is high in administrative and employer contribution costs, as well as one of the most administratively complex plans; and as you guessed – that equates to expensive.
For this type of plan to be worth considering, your small business generally must be highly profitable and as the interwebs puts it – you may be able to squeeze 20 years of retirement savings into 10. The DB plan allows you to set aside more than a regular 401k plan because it’s based on actuarial assumptions based on age, investment return and some other factors. Again, if you’re considering this as an option, I HIGHLY recommend consulting an advisor (like myself – yes, another shameless plug 😊) who is well versed in this space and can run a detailed analysis to determine cost effectiveness. There are certainly scenarios where a defined benefit plan is optimal for a small business, but it should be a part of a bigger financial planning process for the best outcome.
As a small business owner, you may have heard of the government’s attempt at a program called myRA (short for my retirement account). It was a no-fee, no minimum balance, non-deductible Roth IRA for people without access to an employer-sponsored plan. In some ways, it let small business owners off the hook for a retirement plan, but demand was so low that myRA is no longer a program.
Which shouldn’t have much impact on you because as the type of small business owner you are, you WANT to help your employees plan for their retirement. Afterall, they’re the human capital that shows up each day to help your business dreams come to fruition. Providing a retirement plan is one way you’re able to show them your appreciation so you don’t want to skimp on it.
Which Retirement Plan is Right for My Small Business?
The answer to which retirement plan is right for your small business is the same as the answer for many business decisions: it depends on your business, your goals, and your preferences. Regardless of which plan type you choose, I recommend consulting a professional to determine the best course of action. What is right for your business now may not carry into what is right for the future of you and your business, so you’ll want to be sure you’re set up as best as possible.
My team and I are always available for a consult and are happy to answer any questions you may have. If after this three part series you’d like clarification, further explanation, or are ready to take the leap into planning your business’s retirement plan, feel free to contact us at (315) 753-0050 or firstname.lastname@example.org.