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Which Retirement Plans Are Right for Your SMB Clients?

Gusto Editors  
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Do you know which small business retirement account option is best for your clients?

Retirement investment is one of the most valuable benefits a business can offer to its employees. Retirement plans provide security for the future, but the variety of small business retirement plans make it difficult to choose the right one. If you want to learn more about retirement plan options and how to help your small business clients choose the right one for their employees, this article series is for you. 

We are happy to have partnered with CPA Academy to present an informative article series about retirement plan options for you and your clients based on our webinar “401(k) or SEP IRA.” Our host was Nicolle Willson, the retirement consulting director at Guideline, a 401(k) and retirement solution for small business owners. 

The webinar took an in-depth look at different types of retirement investment opportunities and which types are the right fit for your clients. In this article, we will look at small business retirement plans and how to choose the right investment solutions for your small business clients.  

Small employer retirement plans: is 401(k) the best answer?

Several factors need consideration when looking into retirement plans such as how much the employees are paid, the size of the business, and how much liability the owner would like to carry in relation to the plan. When considering these points, small business owners can sift through the options to find the right plan for them.

If the business has several non-highly-compensated employees, NHCEs, 401(k) plans tend to work the best for them. 401(k) is the most recognizable name in retirement investing and attracts workers to companies that provide them. There are a few questions to ask if your clients are considering a 401(k) plan:

“I would say that the vast majority of businesses with NHCEs would do best with a 401(k). Here’s a few questions you can ask. First, is the business looking to be competitive in the benefits landscape? 401(k) plans are the most well-known retirement plan by today’s workers. Therefore, they are widely requested by prospective employees.”

– Nicolle Willson

In addition to being competitive in the market, businesses should also look at who they want contributing to the plan. If owners desire the potential of employee contribution, 401(k) plans will work for them.

“Does the business want to allow employees to contribute to their income? If so, then a 401(k) is a must over an SEP. SEP plans do not allow for employee contributions.”

– Nicolle Willson
Couple business owners using a tablet having a discussion with a businessman in a coffee shop

A third important aspect of choosing retirement plans is owner liability. In the case of a 401(k), business owners either need to be the fiduciary for the plans or hire a fiduciary to manage their employees’ retirement accounts. Taking this into consideration may keep some small business owners from wanting the responsibility of managing their employees’ investments:

“Is the business owner comfortable with being a plan fiduciary? 401(k)s are not a joke to set up and maintain. Although you can outsource a lot of the job nowadays, you do have to commit to doing at least some of the work to keep [the plans] going and take on some liability in doing so. If the owner is not willing to do that, then definitely stay away from a 401(k).”

– Nicolle Willson

If your clients are not willing to spend time and effort managing their employees’ accounts, the 401(k) option probably will not work for them. However, 401(k) is not the only possibility when it comes to retirement investment opportunities. SEP IRAs may fit into the mold your clients desire if they want to be more hands-off in their involvement.

When is the best time to use a small business IRA?

Simplified Employment Pension Plans, or SEP IRAs, offer small businesses an opportunity to invest in their employees’ futures without taking as much responsibility for handling investments. Instead of the owner assuming fiduciary responsibility, the employees control their investment options.  One trade-off for the employee handling their investments is who can contribute to the account.

“Does the owner want to make contributions for the employees? Since employees can’t defer from their pay, the owner is responsible for contributing to the SEP for all employees. If the owner wants to contribute ten percent of compensation to themselves, they have to contribute ten percent of compensation to all eligible employees.”

– Nicolle Willson

Time and responsibility also factor into choosing SEP over 401(k). 401(k) plans require more frequent filings and non-discrimination testing to ensure proper contribution for employees. On the other hand, SEP IRAs simplify the contribution process:

“With SEP plans, you can generally take care of all contributions and reporting obligations once a year. You can even skip years if you want. There’s no obligation to contribute. With 401(k) plans, since employees are contributing year-round, you will generally have year-round responsibilities.”

– Nicolle Willson

The last factor to consider when choosing SEP IRAs is the number of employees the business has. Small, family-owned and operated businesses with only a few employees benefit far more from an SEP because of their simplicity.

“SEP IRAs are usually not going to be the way to go if you have more than a few employees. They’re most popular with small family-run businesses or self-employed individuals.”

– Nicolle Willson

After taking the factors of size, employee contribution, and time into consideration, the decision between SEP IRA and 401(k) becomes less complicated for most business models. However, some business models lie outside of the typical framework. The primary example is owner-only businesses.

Female entrepreneur preparing a package for delivery

Choosing the right small business retirement plans for owner-only businesses

Owner-only businesses have a unique position when considering retirement options. Because the only employee is the owner, the responsibility of investment and contribution falls solely on them. The most significant thing to consider when choosing a plan as an owner-only business is how much they want to contribute to their account.

“Let’s take a look at which vehicle is better for owner-only businesses. We can disregard any other employees, since there are none, so it mostly comes down to how much the business owner wants to contribute to their own account.”

– Nicolle Willson

Business owners can contribute both as the owner and employee of their business when looking at a solo 401(k) because they are the only entity in the organization. Using both the employer and employee contributions allows for the possibility to invest significantly more than an SEP.

“Here we have an example of Abigail. She’s a sole proprietor who has $100,000 of compensation in 2021. If she wants to contribute to a solo 401(k), the maximum she can contribute is $19,500 as her employee contribution. Then 25% of her compensation or $25,000 [in this case] as her employer contribution. Finally, since she’s over the age of 50, [she gets] an additional $6,500 as her employee catch-up contribution, [resulting] in a total of $51,000.”

– Nicolle Willson

On the other side of the fence, the SEP contribution is significantly less unless the business makes more than $232,000 yearly:

“Alternatively, if she wanted to contribute to an SEP, she would only be able to contribute the 25% of compensation ($100,000 in this case) or $25,000 employer contribution only. Note that for 2021, the break-even compensation that allows you to contribute the entire $58,000 limit to either [a 401(k) or SEP IRA] is going to be $232,000.”

– Nicolle Willson

Consequently, choosing the best option for an owner-only business solely depends on how much the owner wants to contribute to their retirement fund. If they want the maximum possible contribution, a 401(k) is the better of the two options.

Learn more about retirement plan options for small businesses

When choosing between different retirement plans, take the time to consider the possibilities. Where one plan may offer different employee incentives, such as matching employee contributions in 401(k)s, other investment opportunities like SEP IRAs open up possibilities for employees to take personal control of their retirement investing. In the end, the best choice is the one that checks the most boxes for the business.

“Retirement benefits are the third most requested benefits by employees, just behind health insurance and paid time off. A 2017 study by the Employee Benefit Research Institute found that almost 6 in 10 workers who are extremely satisfied with their benefits are also extremely satisfied with their jobs.”

– Nicolle Willson

If you would like to learn more about retirement investment opportunities for small businesses, you can watch the entire webinar here. Also, be sure to look out for Part One and Part Two of this article series to learn more about different types of retirement investment opportunities and which are best for your small business clients.

Our mission at Gusto is to help accountants and their clients gain peace of mind while on their financial journey. We currently partner with over 4,500 firms nationwide to promote security and cultivate a positive work environment. Be sure to look into our People Advisory Program to learn how to connect with your clients beyond their finances. We also provide a partner blog full of resources for all your advising needs. Visit our Gusto for Accountants page for more information on utilizing people-based accounting within your firm.

Updated: April 4, 2022

Gusto Editors
Gusto Editors

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