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Retirement Plans for Small Business Owners

Retirement Plan Options for Small Businesses and the Self-Employed

Available Retirement Plan Options for Small Business Owners

Choosing from available retirement plan options for your small business can seem challenging. Which plan will work best for your needs? What happens if you hire employees in the future? What plan allows the type of investments you and your employees want to make? In this article, we’ll discuss the details and benefits associated with each plan. We’ll also offer comparisons to help you select the best plan for your small business.

Individual 401(k) Plan

An Individual(k) plan (Solo 401(k)), is a cost-effective retirement plan for small business owners with no employees (other than a spouse or partners). It also works for employees who can meet specific requirements (work less than 1,000 hours or are under 21). The types of businesses that can establish Solo(k) plans include sole proprietorships, partnerships, limited liability corporations (LLCs), and incorporated companies (including subchapter S-Corps).

Specific benefits associated with an Individual 401(k) plan include:

  • Participants can borrow up to 50% of the account balance up to a maximum of $50,000
  • As the Trustee of your plan, you can have checkbook control of your funds
  • These plans allow for higher contribution limits and the option of making Roth elective deferrals with no income restrictions
  • A brokerage account for the traditional portion of your asset is included with your plan, so you have the freedom to diversify the way you want
  • This plan can invest into any investment the IRS doesn’t prohibit, including all of the investment classes commonly held within a self-directed IRA

What Happens if You Add an Eligible Employee With a Solo(k) Plan?

If you add eligible employees in the future, you cannot continue to use an Individual(k) plan. In this situation, it would be better to go with a SIMPLE IRA or use a third-party administrator (TPA) that offers 401(k)s.

SEP IRA

Simplified Employee Pension (SEP) plans allow the self-employed, partners, or corporation owners a low-cost, easy way to provide retirement benefits for employees. Employers who can provide this plan include self-employed individuals or businesses that don’t currently maintain a retirement plan.

Specific benefits associated with a SEP IRA include:

  • Flexible employer and employee tax-deductible contributions
  • Higher contribution limits versus that of a Traditional IRA (25% of earned income versus $6,000 or $7,000 for catch up contributions)
  • You can make contributions up until the tax deadline of the following year
  • Minimal start-up and facilitation fees
  • RMDs (required minimum distributions) begin at age 72
  • Flexible employer contributions
  • Existing IRA or employer-sponsored plan can rollover or transfer into self-direction
  • Can invest in any permissible alternative asset to build retirement wealth

SIMPLE IRA

Savings Incentive Match Plan for Employees tailors to small businesses with fewer than 100 employees. Employees may choose to defer a pre-taxed portion of their compensation into the plan. Employees include self-employed individuals. Contribution limits for employees under 50 are $13,500 and $16,500 for those 50 and older. Employers can match this contribution by up to 3% of employee compensation.

Specific benefits associated with a SIMPLE IRA include:

  • Low start-up and facilitation costs
  • RMDs (required minimum distributions) begin at age 72
  • Employee salary deferral of up to $12,500
  • Employer match between 1%-3% of employee deferral
  • Can invest in any permissible alternative asset to build retirement wealth

SEP IRA vs. SIMPLE IRA vs. Solo 401(k)

To better understand how these plans differ, let’s look at each plan through a small business owner’s or employee’s eyes.

Individual 401(k) Plan – Scenario

John is 48 years old and owns a small pool cleaning company in which he is the only employee and does all the work. John’s yearly salary is $200,000 a year. As the business owner, John can make an elective deferral as the employer and as an employee. Let’s assume he would like to contribute as both employer and employee.

In an Individual 401(k), a yearly contribution consists of two sources. The first source is employee elective salary deferrals of up to $19,500. The second is the company’s match or employer profit-sharing contribution up to 25% of total compensation. The total of these two amounts cannot exceed $58,000 for individuals under age 50 or $64,500 for those age 50 and older. With employee elective deferrals, John as the employee can elect to defer up to $19,500. Then, John as the employer can match up to the total limit of $38,500. This gives John the maximum contribution limit of $58,000.

SEP IRA – Scenario

Adam works at Taylor’s Bakery, a company that offers a SEP IRA. Taylor, the bakery owner, makes $200,000 a year. Taylor can choose to make large or small contributions to Adam’s retirement. This may depend on the bakery’s current financial status. Every employee in the company receives the same percentage of contribution.

Adam cannot invest his income into the SEP IRA. The contribution limit for a SEP IRA is 25% of net earnings up to $58,000. If Taylor, the owner, makes $200,000 and wanted to maximize Adam’s contribution, he could contribute $50,000.

Adam does not need to opt into the plan as he would in a SIMPLE IRA or 401(k). He automatically gets it since he is over the age of 21, has worked for the bakery for 5+ years, and received $650 in the current year. In this scenario, if Adam makes $50,000 a year, he needs to contribute $12,500 to his plan. This shows that there are better plans for him right off the bat, a SIMPLE IRA or a 401(k).

SIMPLE IRA – Scenario

Matching Contributions up to 3% of Compensation

Sarah works at Screen Savers, a small business that offers SIMPLE IRAs to its employees. She earns $50,000 and contributes 10% of her salary. Her employer is only able to match up to 3% under the plan. This means that Sarah’s $5,000 employee contribution (10% of $50,000) will be matched by a $1,500 employer contribution (3% of $50,000) for a total SIMPLE IRA deposit of $6,500.

Contributions of 2% to All Eligible Employees

Andrew and Liz each earn $40,000 at their company. Their employer offers a SIMPLE IRA plan and has elected to contribute 2% to every employee with a SIMPLE IRA. Andrew contributes 10% of his salary, totaling $4,000 (10% of $40,000), while Liz contributes nothing. Both employees will still receive 2% employer contributions regardless of their contribution activities.

Contribution Considerations for Small Business Owners

Mithcell is 38 years old. He owns Paint By Numbers, a small painting business where he makes $100,000 and has no eligible employees. Here’s what his maximum contributions could be under each plan.

Individual 401(k): $44,500

SEP IRA: $25,000

SIMPLE IRA: $13,500

How Mitchell’s Contributions Change When Adding Eligible Employees

Here’s what it would look like if Mitchell adds eligible employees to his company.

Individual 401(k): Mitchell could not keep his plan. He would have to change his business’s retirement plan to a 401(k), SEP IRA, or SIMPLE IRA.

SEP IRA: $25,000 to his plan + 25% of each eligible employee’s salary to their plan.

SIMPLE IRA: $13,500 + matching employees’ contributions or a minimum of 2% of each employee’s salary up to $13,500.

To review Individual 401(k)s and retirement plans for small business owners further, check out our informational flyer.

If you would like to know more about the different types of available retirement plans for the self-employed, please visit www.midlandtrust.com or call us at (239) 333-1032. We’re here to help!

MIDLAND TRUST COMPANY, NOR ITS AFFILIATES OR SUBSIDIARIES (COLLECTIVELY REFERRED TO AS “MIDLAND”), IS NOT A FIDUCIARY: Midland’s role as the Custodian and/or Administrator of self-directed retirement accounts is non-discretionary and/or administrative. The account holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account, and is responsible for conducting his/her own due diligence. Midland has no responsibility or involvement in selecting or evaluating any investment and does not conduct due diligence on any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.