Offering a small business retirement plan for your employees can not only decrease your tax burden
71% of employees who are offered a retirement plan are satisfied with their overall benefits package, compared to just 38% of those who don’t have access to one, according to industry research. There are a variety of small business retirement plans to choose from, each with their pros and cons and requirements.
Here are the most common small business retirement plans:
Note: Contribution limits listed are 2019 numbers.
Traditional 401(k) plans
Over the past 40 years, 401(k) plans have turned into one of the most common types of employer-sponsored retirement plans.
Employees like 401(k) plans because they can easily invest via automatic payroll deductions, get tax-deferred savings, and have control over their contribution levels and investment choices. Business owners like 401(k) plans because they have lots of flexibility in setting up eligibility requirements, vesting schedules, matching, and profit sharing.
Who can offer a traditional 401(k) plan?
Almost any company can offer a 401(k), but some nonprofits and businesses without employees may prefer 403(b) plans and Solo 401(k) plans (described below), respectively.
What are the contribution limits?
Employees may contribute up to $19,000 each year—and up to $6,000 more if they are 50 or older. Your business may also choose to match employee contributions or offer profit-sharing to help employees save up to 100% of their compensation or up to $56,000 ($62,000 for those 50 or older), whichever amount is lower. Employer contributions cannot exceed 25% of the compensation paid to eligible employees participating in the plan.
What are the tax benefits?
Employee 401(k) contributions are pre-tax. When distributions are taken in retirement, the money is taxed as ordinary income at a rate that is usually lower than when employees are earning wages. Employers can receive tax credits and deductions as a result of offering a traditional 401(k) plan.
What are the compliance requirements? There are three key requirements for offering a traditional 401(k), some or all of which are typically handled by a 401(k) provider.
- Fiduciary duty: This is a legal obligation to act in the best interest of another party. It means you have to make sure your retirement plan is run in the best interest of your employees.
- Annual nondiscrimination testing: This is a series of tests to ensure all employees have an opportunity to participate.
- Annual filing: Small business owners must file Form 5500 with the IRS/DOL annually.
Safe Harbor 401(k) plans
This type of small business retirement plan is a subset of the traditional 401(k) plan. It deserves a little extra attention because it allows employers to skip the annual nondiscrimination testing.
Who can offer a Safe Harbor 401(k) plan?
Similar to SIMPLE IRA plans (below), a small business can qualify for a Safe Harbor 401(K) by committing to contributing to their employees’ accounts.
What are the contribution limits?
As with the traditional 401(k), employees may contribute up to $19,000 a year to a Safe Harbor 401(k). This amount increases to $25,000 for those who are 50 or older. Safe Harbor 401(k) plans also require an employer match, and all employer contributions vest immediately.
There are three types of qualifying matches:
- Basic match: The employer matches 100% of employees’ contributions, up to 3% of each employee’s compensation. Then they match 50% of the next 2% each employee contributes.
- Enhanced match: The employer matches 100% of employees’ contributions, up to 4% to 6% of each employee’s compensation.
- Non-elective contribution: The employer contributes at least 3% of each employee’s compensation, whether or not the employee makes a contribution.
What are the tax benefits?
Employee contributions to Safe Harbor 401(k) plans are made pre-tax, and there are tax credits and deductions for employers.
What are the compliance requirements?
One of the highlights of Safe Harbor 401(k) plans is that they allow businesses to skip nondiscrimination testing. However, small business owners do still have a fiduciary duty to ensure the Safe Harbor 401(k) is run in the best interest of their employees and must still file a Form 5500 with the IRS/DOL each year.
403(b) plans
Designed specifically for nonprofit organizations, 403(b) plans operate similarly to traditional 401(k) plans, except several compliance requirements are relaxed. Long-tenured employees can also contribute more via a 403(b) than with a traditional 401(k) plan.
Who can offer a 403(b) plan?
501(c)(3) nonprofit and educational organizations, plus certain ministers.
What are the contribution limits?
Much like 401(k) plans, employees under the age of 50 may contribute up to $19,000 annually while employees 50 or older can contribute an additional $6,000 each year. The organization itself can also choose to match employee contributions or offer a profit-sharing plan.
The maximum annual contribution limit for both employee and employer contributions is $56,000 ($62,000 for those 50 or older) or 100% of the employee’s compensation, whichever total is lower.
There is one special caveat for 403(b) plans: employees with more than 15 years of service at their organization can contribute up to an additional $3,000 each year.
What are the tax benefits?
For employees, contributions are made before their income is taxed. When they take distributions in retirement, the money is taxed as ordinary income at a rate that is typically lower than when the employees are earning wages.
What are the compliance requirements?
Most nonprofit organizations have similar obligations as other 401(k) sponsors—they have to file Form 5500, pass nondiscrimination testing, and follow fiduciary duties—but some organizations such as churches and government entities are exempt from these additional requirements.
Solo 401(k) plans
Solo 401(k)s are designed for the smallest of small businesses—those with no employees other than the owner and the owner’s spouse. These plans offer all the benefits of a traditional 401(k) but have very few compliance requirements.
Who can offer a Solo 401(k) plan?
Businesses where the owner and the owner’s spouse are the only employees.
What are the contribution limits?
Up to $56,000 in 2019, including up to $19,000 in employee contributions. These limits increase by $6,000 if an employee is 50 or older. As with traditional 401(k) plans, Solo 401(k) employer contributions can’t exceed 25% of the compensation of eligible employees.
What are the tax benefits?
Contributions are made before the owner’s (or the owner’s spouse’s) income is taxed. When they take a distribution in retirement, it is taxed as ordinary income, which is usually at a lower tax rate than it would have been when the owner or the owner’s spouse was earning wages.
What are the compliance requirements?
Unlike traditional 401(k) plans, no nondiscrimination testing applies, and there are no fiduciary responsibilities. If assets in the Solo 401(k) plan exceed $250,000, you will need to file either a Form 5500-EZ (if you choose to file via mail) or a Form 5500-SF (if you choose to file electronically) each year with the IRS/DOL.
SIMPLE IRA Plans
From a compliance standpoint, SIMPLE IRAs are less complicated than other small business retirement plan types. With this type of plan, you can skip nondiscrimination testing by committing to making contributions to your employees’ accounts. However, there is one key drawback: maximum contribution levels are lower than those of other options.
Note: Safe Harbor 401(k) plans offer similar compliance benefits with higher contribution limits.
Who can offer a SIMPLE IRA plan?
Any small business, but generally those with 100 or fewer employees.
What are the contribution limits?
Employees less than 50 years old can contribute up to $13,000 annually. Those 50 or older can contribute an additional $3,000.
What are the tax benefits?
There is no tax on employees’ contributions, and distributions taken in retirement are likely to be taxed at a lower rate. Employers can also get tax credits for sponsoring SIMPLE IRA plans.
What are the compliance requirements?
There are no testing or filing requirements, but you must be willing to make contributions that vest immediately to your employees’ accounts. You can choose one of the following contribution methods:
- Match each employee’s contribution, up to 3% of their compensation
- Contribute 2% of each employee’s compensation, regardless of whether they contribute to their own SIMPLE IRA account. The annual maximum is $5,600.
SEP IRA Plans
This type of employer-sponsored retirement plan is both sponsored and funded by employers. Companies have the flexibility to decide how much to contribute, and there are no testing or reporting requirements. SEP IRA plans are easy and cheap to administer because employees set up their own SEP-IRA accounts to receive employer contributions. However, SEP IRAs can wind up costing a lot since the employer is making all the contributions.
Who can offer a SEP IRA plan?
Most companies, but SEP IRAs are most popular with smaller companies because the cost of contributions can add up with a larger team.
What are the contribution limits?
Employers make all the contributions to these plans, which can be up to $56,000 annually. Contributions may not exceed 25% of an employee’s compensation.
What are the tax benefits?
The savings are taxed at ordinary income tax rates when employees take distributions in retirement. This is typically at a lower tax rate than when the employee is earning wages. Companies may write off contributions as a business expense.
What are the compliance requirements? Most SEPs require that all employees receive the same percentage of their income in contributions. Employers have the flexibility to change contribution levels from year to year, though. And there are no filing or testing requirements.
Other plan types
The retirement plans listed above should work for almost every type of small business. There are a few other plan types, like 457(b) plans that are designed for government employees and certain non-profit executives, Employee Stock Ownership Plans that are embraced by many startups, and several others outlined by the IRS.
There are also some state-sponsored IRA plans that make it easy for employees to save, although they often have higher fees and lower contribution limits than employer-sponsored plans.