Q&A: I’m the owner of a small business. What retirement plan options do I have for my employees?
Q&A: I’m the owner of a small business. What retirement plan options do I have for my employees?
By: Stacey Nickens
There are three main retirement plan options for small business owners: SIMPLE IRAs, SEP IRAs, and 401(k)s. Let’s review each of these plans and their rules.
SIMPLE IRAs
The Savings Incentive Match Plan for Employees (SIMPLE) IRA allows both employees and employers to contribute to the plan. Your employees can choose whether or not they want to contribute. For those who choose to contribute, employees can opt to have automatic withdrawals pulled from their paycheck and deposited into the SIMPLE IRA. You as the employer are required to contribute at least 2% of your employee’s salary to the plan. Alternatively, you can offer a matching contribution and are allowed to match up to 3% of your employee’s income.
In order to use a SIMPLE IRA, your business must generally have fewer than 100 employees. Additionally, while SIMPLE IRA contributions are tax deductible for both the employee and employer, SIMPLE IRAs have smaller contribution limits than do 401(k)s, limiting the tax savings. However, employers can also claim a tax credit to reclaim 50% of SIMPLE IRA startup costs, with a maximum credit of $500 per year for three years.
SEP IRAs
A Simplified Employee Pension (SEP) IRA is often appealing to small business owners. It doesn’t have the same start-up and operational costs of other plans, and businesses of any size can offer SEP IRAs. Only employers can contribute to SEP IRAs. Employees cannot add their own contributions, unless you’re self-employed and contributing to a SEP IRA as your employer. Employers can contribute up to a quarter of their employee’s salary, as long as the contribution does not exceed annual maximums. Additionally, employers must contribute the same percentage of employee salaries to each SEP IRA account. Employers can also adjust their contributions from year-to-year, flexibility that may be helpful if your business’s profit fluctuates annually.
401(k)s
Finally, 401(k)s are often funded with employee contributions. You as the employer may also contribute, but you are not required to make contributions. Employees will contribute a set percentage of their wages, and employers can match all or part of these contributions.
Not only will the deduction from pay reduce employee tax liability, employers also benefit from their contributions to a 401(k). Employers can deduct their contributions to an employee’s 401(k) as long as the contributions do not exceed annual limits. Moreover, 401(k)s offer greater contribution limits than do SIMPLE IRAs, allowing for greater tax savings for both the employee and employer.
At the same time, 401(k) plans are subject to discrimination tests by the U.S. Department of Labor and often have higher service costs than with SIMPLE IRAs.
With all of the above plans, withdrawals are taxed as ordinary income. In most years, employees who take withdrawals before the age of 59 ½ may face a 10% early withdrawal fee. Employees also must generally begin taking Required Minimum Distributions (RMDs) from the above account types beginning at the age of 72.
To determine the best plan for your business, contact ELM3. We can help you develop a business plan that meets you and your employees’ needs.
