Which Retirement Plan Should I Choose For My Company?
Business owners have several options when it comes to retirement plans, but which ones make the most sense? In this article, I’ll cover the four primary options along with a few questions that may be on your mind.
Solo 401(k)
Who is this for? This option is available to those that are self-employed with no other employees (other than a spouse). You can have multiple owners and still have a solo plan. You can have this as a corporation, sole proprietor, or partnership. I particularly like this option for S corp owners who take a salary.
How much can I put in? The reason I like this for an S Corp is there are two components to the solo plan: employee contributions and employer contributions. For 2022, you can put $20,500 of your salary (plus another $6,500 if you’re over age 50) into the plan as your contribution. This saves on federal income taxes, but you still pay your normal payroll taxes (unless you choose the Roth option - aka you pay taxes up front, but not when you withdraw in retirement). Then the company could make a profit sharing contribution on top of that to get to the annual limit of $61,000 ($67,500 if you’re over 50). It’s important to note that the profit sharing contribution can’t exceed 25% of your gross income for a corporation or 20% if a sole proprietor or partnership. Company contributions are a tax deductible expense.
Am I required to give employees a match or profit share contribution? N/A. This isn't available if you have employees. You are also not required to give yourself a contribution.
Does it require a lot of administrative work? Generally no. You do not have non-discrimination testing like you would for a regular 401(k). You also don’t have to file a form 5500 if you have less than $250,000 in the plan. You must still adopt a plan (sign paperwork) and send in contributions.
What are the fees? Generally, you can find a reputable company for little to no cost. For example, I would likely use Charles Schwab where there are $0 account fees and many fund options with no trading fees. Not all offer a Roth and after-tax contribution options, so double check if that’s a requirement for you as there may be additional fees for more complexity.
SEP IRA
Who is this for? Any employer can open a SEP IRA. I particularly like these plans for LLC partnerships or sole proprietors with no employees. The reason being is that many of these structures of business may not have employees and the owners may not take a salary throughout the year. The SEP allows you to determine if you want to make a contribution to yourself by your tax filing deadline. This helps to see how you may reduce your taxes with a contribution year to year.
How much can I put in? Typically the max is 25% of compensation (20% if self employed) or $61,000. This is pre-tax money only, there is no Roth option under a SEP. However, you can look to do a Roth conversion on the account as needed.
Am I required to give employees a match or profit share contribution? Yes! You must give the same percentage you give yourself to your employees. However, you can limit eligibility to employees that are over 21, worked for you 3 out of the past 5 years, and earned at least $650 in 2022. Even so, this option can get expensive if you have employees that are eligible. The money you give them is 100% vested (it’s all theirs right off the bat).
Does it require a lot of administrative work? Getting started takes a bit of paperwork to adopt the plan and set-up the accounts for each eligible employee. You’ll likely file a 5305-SEP to get it going , but there are no other annual filing requirements or testing requirements.
What are the fees? Generally, you can find a reputable company for little to no cost. For example, I would likely use Charles Schwab where there are $0 account fees and many fund options with no trading fees.
SIMPLE IRA
Who is this for? Any employer who has less than 100 employees can open a SIMPLE IRA. If you have employees and are willing to give them a required contribution amount, this can be a good option stepping into a retirement plan.
How much can I put in? In 2022, you can put $14,000 in employee contributions (again, a good idea for S corp owners who take a salary), plus $3,000 extra if you’re over age 50. There is no Roth option. Also, you probably want to avoid a Roth conversion until you’ve been in the plan for 2 years. There is a special tax rule that hits you for a 25% penalty if you withdraw within the first 2 years.
Am I required to give employees a match or profit share contribution? Yes. You have the choice of providing a 3% match or a 2% profit sharing. An employee would get the match if they put money in and up to 3% of compensation only. However, the 2% profit sharing must be given to all eligible employees regardless if they put money in the plan or not. Employees are eligible to be in the plan if they made at least $5,000 in any of the prior 2 years and are expected to make $5,000 this year. The match or profit sharing amount is 100% vested. The company contribution is a deductible expense that you can discuss with your accountant.
Does it require a lot of administrative work? You need to choose and adopt a plan. You’re likely sending in employee contributions on a per payroll basis. So it can add a bit more on the “day to day”. There is no non-discrimination testing or annual filings.
What are the fees? Generally, you can find a reputable company for little to no cost. For example, I would likely use Charles Schwab where there are $0 account fees and many fund options with no trading fees.
401(k)
Who is this for? Any company with any amount of employees can open a 401(k) plan.
How much can I put in? For 2022, you can put $20,500 of your salary (plus another $6,500 if you’re over age 50) into the plan as your contribution. This saves on federal income taxes, but you still pay your normal payroll taxes (unless you choose the Roth option- aka you pay taxes up front, but not when you withdraw in retirement). Then the company can do a profit sharing or match contribution on top of that. The annual limit of all the money that can go in is $61,000 ($67,500 if you’re over 50). It’s important to note that the employer contribution can’t exceed 25% of your gross income. The company contribution is a deductible expense that you can discuss with your accountant.
Am I required to give employees a match or profit share contribution? No. There is flexibility in offering or not offering a match or profit sharing contribution. Typically, there is no minimum requirement to offer one or the other (unless your plan is top heavy - 60% or more of the assets are held by key employees). Additionally, you can tie a vesting schedule to the money you give employees where they earn a portion of it over time, up to a maximum 6 year schedule. There are certain optional provisions called Safe Harbor contributions that allow you to pass certain non-discrimination testing requirements. It’s typically a 4% total match or 3% profit sharing to call. That money is 100% vested immediately.
Does it require a lot of administrative work? Relative to the other types of plans, yes. Sending in contributions shortly after payroll is run is the typical day to day responsibility. You can oftentimes connect your payroll provider and 401(k) provider to make this more streamlined. There are many required notices that have to go out, you’re responsible for choosing the investments in the plan, you design how you want your plan to work, an annual tax filing requirement (Form 5500), annual non-discrimination testing, employee education, fee reviews and more. There are just a lot more rules and regulations to follow with these kinds of plans, but the flexibility and opportunity with them is also much greater.
What are the fees? This is a hard one to say. Not all plans look alike, believe it or not. You can have a $1,000,000 plan with 10 participants ($100,000 average account balance) and one $1,000,000 with 100 participants ($10,000 average account balance). Match and no match. Profit sharing and no profit sharing. You can hire 401(k) providers and advisors to take on part of your fiduciary duties and that comes with fees as well. There are many factors that go into it. Getting three to four bids from different providers and understanding the services offered is the best way to understand fees. If you have more than 120 eligible employees, you’ll need to factor in roughly $10,000 for a required third party audit of the plan. You may also want to look at pooled employer plans (PEPs), which can help reduce the cost, but also some flexibility.
Finally, it’s important to note that the IRS incentivizes small business owners to start retirement plans and they do so by offering tax credits over the course of 3 years. You can click here to learn more.
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