The Best Retirement IRAs and 401ks for Small Business Owners

From an Individual 401k to Executive Retirement Plans and Business 401ks and Everything in Between… Find the Plan that is Right for Your Small Business

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Choosing between Individual 401k (Solo 401k), SEP IRA, Profit Sharing Plans, Personal Defined Benefit Plans and 403b retirement plan
Choosing the Right Plan for Your Business

If you own your own business, you are probably used to setting your own path and creating your own rules.

As such, Small Business Retirement planning is for you. You can probably design a plan that uniquely meets your goals for:

  • The amount of money you wish to contribute
  • The amount you will contribute on behalf of employees
  • Deadlines for creating and putting money into the plan
  • How difficult or easy it is to administer the plan
  • The costs of administering the plan
  • The types of investments available to you and/or your employees
  • Additional benefits for company executives

Below you will find an overview of most of the top retirement plans for small businesses.

Individual 401k – also known as a Solo 401k

An Individual 401k is also known as a Solo 401k. It is a plan that enables sole proprietors to make substantial pre-tax salary deferrals and profit sharing contributions.

The Individual 401k – along with the SEP IRA – are the most popular retirement plans for self employed individuals. The primary differences between the plans are:

  • The Individual 401k requires slightly more administrative responsibility than the SEP IRA
  • The Individual 401k has slightly higher contribution limits
  • You can borrow against your Individual 401k. You can not borrow against your SEP IRA. (Although you could always convert your SEP IRA to an Individual 401k if you thought it was necessary at a later date.)
  • Administration: There is very little administrative responsibility for an Individual 401k, but more than is required with a SEP IRA
  • Annual Contribution Limit: Up to $49,000 for the business owner and their spouse ($15,500 each for the owner and spouse plus up to 20% of the income from the business). And, for those age 50+ there is an additional $5,000 catch-up contribution provision.
  • Employer Matching: not applicable.
  • Can You Borrow Against It?: Yes
  • Contribution Deadline: An individual 401k must be funded by your tax filing deadline.
  • Number of Employees: None. This is a plan for a sole proprietor.
  • Best For: Self-employed individuals and owner-only businesses looking for high contribution limits. A good plan if you don’t have any other employees other than your spouse.

SEP IRA

SEP IRA stands for Simplified Employee Pension Plan.

A SEP IRA requires very little administration and tax filing is not required. A sole proprietor may set up a SEP IRA, but if you have employees, they must be included in the plan.

This could be the right choice for you if you want to make sizeable retirement plan contributions for yourself and any eligible employees.

  • Administration: The SEP IRA is considered to be one of the easiest small business retirement plans to set up and maintain.
  • Annual Contribution Limit: Up to $49,000
  • Employer Matching: The employer may contribute up to 25 percent of the employee's wages to the employee's SEP IRA account.
  • Can You Borrow Against It?: No
  • Contribution Deadline: Generally, a SEP IRA must be funded by your tax filing deadline.
  • Number of Employees: All employees age 21 or older who earned $450 or more during the current year if they have worked for the business in 3 of the past 5 years must be included in a SEP plan.
  • Best For: Self-employed individuals and business owners with employees who want a plan that’s easy to set up and maintain, with no tax filing required.

    A SEP IRA is also good for sole proprietors, partnerships, incorporated and unincorporated small businesses including Sub S corporations, and individuals with self employment income even if they are covered by their employers retirement plan such as a 401k, 403b or 457 plan are eligible for a SEP IRA.

Simple IRA

A SIMPLE (Savings Incentive Match Plan for Employees) IRA is more robust than a SEP IRA but not as complex as a 401k.

Eligible employees can fund their own accounts by way of regular salary deferrals; you make additional contributions to their accounts. This could be the right choice for you if you’re a small business owner with no more than 100 employees.

  • Administration: The SIMPLE IRA has a higher administrative overhead than an SEP plan, comparable to that required by a 403(b) program.
  • Annual Contribution Limit: $11,500 (Employees age 50 or over can make a catch-up contribution of up to $2,500)
  • Employer Matching: Employers are required to make either matching contributions or nonelective contributions (you are required to match each employee’s salary reduction contributions on a dollar for dollar basis up to 3 percent of the employee’s compensation).
  • Number of Employees: You can set up a SIMPLE IRA plan only if you had 100 or fewer employees who received $5,000 or more in compensation from you the preceding year.
  • Best For: Self-employed individuals and business owners with employees who want a plan that’s easy to set up and maintain, with no tax filing required.

Defined Contribution Plans

Defined contribution plans are pension-style retirement plans where the defining factor is the amount of money contributed to the plan.

There are numerous options for setting up a defined contribution plan.

Profit Sharing Plan

A profit-sharing plan is a qualified retirement plan that allows you to contribute for yourself and any eligible employee. This could be the right choice for you if you’re self-employed or a small business owner with employees and you want more control over vesting and employee participation.

  • Administration: Profit Sharing retirement plans have fairly high costs of administration, though lower than those on personal defined benefit plans. The plan sponsor retains a large degree of control over the investment of the assets under management by the profit sharing plan, which can lead to significant overhead.
  • Annual Contribution Limit: Defined contribution plans are subject to IRS limits on how much can be contributed, known as the section 415 limit. In 2010, the total deferral amount, including employee contribution plus employer contribution, was limited to $49,000 or 100% of compensation, whichever is less. The employee-only limit in 2010 was $16,500 with a $5,500 catch-up for employees above the age of 50.
  • Employer Matching: Employers may contribute any amount up to the full amount of the employee’s compensation or $49,000, whichever is less. There is no requirement that the employer match the employee’s contributions to the Profit Sharing Plan. Employer contributions up to 25% of each employee’s compensation are tax deductable.
  • Number of Employees: There is no limit on the number of employees that can be serviced through a profit sharing plan.
  • Best For: Small business owners who want to contribute for themselves and any eligible employees.

Money Purchase Pension Plan

A Money Purchase Pension Plan, like a Profit Sharing Plan, is a Defined Contribution Plan that permits you to contribute defined amounts towards a retirement pension plan. Unlike a Profit Sharing Plan, rather than deciding to contribute a specified amount ($10,000), you decide to contribute a specified percentage of every employee’s salary (5%). The overall administrative costs are less than those of a Profit Sharing plan, but the cap on contributions from the Employer is also lower.

  • Administration: Money Purchase Pension Plans are quite variable, and can be as complicated or simple as you like. You are required only to file an IRS form 5500 once per year in order to establish them. A Discrimination test is required to ensure that benefits do not unfairly advantage those with higher compensation.
  • Annual Contribution Limit: The maximum amount that can be contributed is either the section 415 limit ($49,000 in 2010) or 25% of the employee’s salary, whichever is lower.
  • Employer Matching: Employers and Employees both contribute to the Plan. The sum total of all contributions cannot exceed the annual limit, and the Employer is required to establish ahead of time what percentage they intend to contribute.
  • Number of Employees: There is no limit on the number of employees that can be serviced through a money purchase pension plan.
  • Best For: Small business owners who want to contribute for themselves and any eligible employees.

Personal Defined Benefit Plan

A traditional defined benefit plan is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. This is the classical Pension plan. The majority of such programs use a formula (usually called a final salary plan) to determine the precise amount of money an employee is eligible for, depending on the salary earned at retirement and the years worked. The amount available is traditionally available as a monthly pension or a lump sum. In some cases small business owners who are close to retirement can use this kind of plan to contribute a lot of money very quickly into a retirement plan.

  • Administration: Overhead on Personal Defined Benefit Plans are fairly high. Employers using this plan must pay premium to the Pension Benefit Guaranty Corporation, a government agency whose role is to provide timely and uninterrupted payment of pension benefits. Most employers concerned about administrative costs tend to opt for Defined Contribution Plans instead.
  • Annual Contribution Limit: The contribution amount for Personal Defined Benefit Plans is a complicated calculation based on several factors, including the employee’s age, current earnings, and planned retirement age. Contributions to such plans are not optional for the employer. Contributions to such a plan for yourself and all eligible employees are tax deductible.
  • Employer Matching: Employers are required to contribute a defined amount to each employee’s plan, based on calculations involving the above factors. Generally-speaking, these plans require a contribution of at least $80,000 minimum no matter how few employees are on the plan. Employees themselves are not permitted to contribute towards the plan.
  • Number of Employees: Personal Defined Benefit Plans do not have a maximum number of employees.
  • Best For: Self-employed businessmen, or businesses with less than five employees, able to meet the overhead costs and contribute at least $80,000 annually.

403(b)

Similar to the traditional 401k plan, the 403(b) is a tax-advantaged, retirement savings plan available only to select individuals and organizations. In order to qualify for a 403(b) program, you must be either a public education organization, a certain type of non-profit employer, or a self-employed minister. Like a 401k program, salary deferrals are made before income taxes, and are considered tax deferred until withdrawn. 403(b) programs may also include designated Roth (after-tax) contributions.

  • Administration: One of the major selling points of the 403(b) program is the reduced administration costs relative to a traditional 401k. Annual reporting requirements are less costly, and the plan is not subject to discrimination testing.
  • Annual Contribution Limit: Up to $49,000 per employee, with an additional $5,000 “catch-up” contribution for employees above the age of 50.
  • Employer Matching: As with a normal 401k plan, employers may match employee’s contributions to an extent, which may vest over the course of several years, to induce the employee to remain with the company.
  • Number of Employees: 403(b) plans have no maximum or minimum limits on the size of enrollment.
  • Best For: Companies that meet the eligibility criteria and who are interested in starting a traditional 401k-style retirement plan are often best served with a 403(b) plan instead, due to the reduced overhead costs.

Employee Stock Ownership Plan

Employee Stock Ownership Plans (ESOPs) are retirement plans oriented around employee ownership of company stock. Traditionally, these programs are concentrated around special Employee-Owned corporations with shares not sold on public stock markets. Generally speaking, such programs are considered “wealth-building” rather than “retirement security” plans, as the money is invested in company stock, and therefore the plan can lose value if the company performs poorly.

  • Administration: Overhead on Employee Stock Ownership Plans can be extremely time and capital-consuming. Major company decisions need to be made with all employees in mind, and participants must be allowed to vote their allocated shares at least on major issues, such as closing or selling the company.
  • Annual Contribution Limit: Plan participants can contribute up to 25% of their pay. The contributions are used to purchase shares of company stock from selling owners. Dividends can be paid directly into the ESOP in excess of this limit, if desired.
  • Employer Matching: ESOPs are generally funded through tax-deductible corporate contributions to the program. There is no specific limit attached to these contributions.
  • Number of Employees: There is no limit to the number of employees who can participate in an ESOP.
  • Best For: Employee-owned companies who wish to incent employees further by providing individual vesting accounts of company stock.

Work With an Experienced Retirement Planning Professional

Learn about choosing the right institution to help you set up the right plan for your business. Or, continue here to speak with a prescreened and experienced Small Business Retirement Planning Professional who can help you choose and set up the right plan for you.

Get Matched with the Right Retirement Advisor for Your Small Business

Find the Best 401k, IRA and Other Products to Improve Your Tax Efficiency, Employee Rentension and More