When you’re in business for yourself, you become responsible for a lot: the hours you work, the services you provide, growing your team, and of course, saving for retirement.
It’s challenging to build a retirement plan that will grow with you, and there are a lot of options for small business owners to consider. Here’s an overview of retirement savings plan options for small business owners and how to pick the right plan for you.
What To Look For In A Small Business Retirement Plan
A major challenge small business owners face when deciding on a retirement plan is a lack of information and overall knowledge of the subject. With everything else on your plate, it can be easy to either forget about planning for retirement or choose a savings plan without doing enough research.
Selecting the right retirement plan starts with research—you need a 360-degree view of all options available to you and your employees. This includes a breakdown of applicable expenses, including administrative fees, investment opportunities, and contribution limits for both the employer and employees.
As you consider if you’d like to contribute to your employees’ plans and how much, keep in mind that contributing can be a great incentive to retain top talent.
When deciding on a retirement plan, it’s essential to choose a flexible plan that can grow with you. If you have a small team now but are growing quickly, you and your team may need different options when you’re a 20-person versus a 100-person team.
Option #1: A SEP IRA
A Simplified Employee Pension (SEP) plan is a retirement savings plan that allows employers to set aside money in retirement accounts for themselves and their employees.
Typically, the business owner solely contributes to the plan on the employee’s behalf, but employees could also make individual contributions in a traditional IRA, depending on the plan.
2022 contribution limits: Contributions cannot exceed the lesser of 25% of the employee’s salary or $61,000 for 2022.
Contribution structure: Any money you contribute is usually tax-deductible for you and the employees, and contributions are tax-deferred. Employers must contribute the same percentage for every employee, including yourself. So if you defer 10%, you’ll need to contribute at least that amount for every employee.
SEP-IRA plans are a great option for small businesses because they allow for significant contributions and are flexible for the employer. Employers don’t have to contribute to the account each year, which could be nice if your business has substantial fluctuating income. They are also relatively low cost and simple to maintain.
Unfortunately, SEP IRAs do not allow ‘catch up’ contributions like other retirement options, and early withdrawals are subject to a 10% penalty and income taxes. Any contributions are also vested immediately, which limits employees’ incentive to commit to your business long-term.
Option #2: SIMPLE IRA
A Savings Incentive Match Plan for Employees, also known as a SIMPLE IRA, is a start-up retirement savings plan for small businesses with 100 employees or less. In this retirement savings plan, employers and employees can contribute tax-deferred.
2022 contribution limits: For employees, the 2022 contribution limit is $14,000 or $17,000 if 50 or older.
Contribution structure: Employer contributions are mandatory for SIMPLE IRAs. Employers have two options for contribution limits and must pick one:
Option #1: 100% dollar-for-dollar match of employee contributions up to 3% of employee’s compensation.
Option #2: A contribution of 2% of each employee’s compensation with a max contribution of $305,000.
SIMPLE IRAs can be an excellent option for small businesses because employer contributions are often deductible, contributions are pre-tax, and the account grows tax-deferred. The setup is also relatively simple (just like the name implies!), and it’s cost-effective to run and maintain due to low administrative costs.
However, compared to other options, the contribution limits for SIMPLE IRAs are much smaller, limiting employees’ ability to reach retirement goals. Also, unlike a SEP IRA, contributions are required every year for SIMPLE IRAs.
One main disadvantage with SIMPLE IRAs is that the withdrawal penalties are steep. If you withdraw or roll over funds within 2 years of opening your account, the penalty is 25%! There are always penalties for early withdrawals from retirement accounts, but 25% will hurt more than 10%.
Option #3: 401(k) Plans
A 401(k) is probably the retirement plan you’re the most familiar with! A 401(k) plan is a company-sponsored retirement account where employees can contribute a percentage of income from their paycheck, and employers can match those contributions.
Unlike SIMPLE and SEP IRAs, employers can offer two types of 401(k) plans: Traditional and Roth. Traditional plans allow for pre-tax contributions, and all withdrawals in retirement are taxable. Roth plans allow for post-tax contributions, and all withdrawals are tax-free. Pro tip: Mechanically, a Roth 401(k) contribution is very similar to that of a Roth IRA without the income thresholds.
2022 contribution limits: Participants can contribute up to $20,500 in 2022. Employees who are 50 and older can contribute an additional $6,500 in catch-up contributions. As the employer, you may match employee contributions but don’t have to. If you do, keep in mind that the total contribution limit for both the employee and employer is the lesser of 100% salary or $61,000 (or $67,500) in 2022.
Contribution structure: Employees can decide if they would like to participate in the plan or not. Traditional plans allow for pre-tax contributions, while Roth plans are post-tax. Employers have the opportunity to also contribute to their employees’ plans.
401(k) plans are great options for retirement savings accounts because there are more investment options, and employees can save more for retirement each year. It’s also possible to add a Roth 401(k) option. This feature enables the business owner and employees to contribute to their retirement after-tax, where future growth and distributions remain tax-free!
On the flip side, 401(k)s involve more administration and paperwork and are more expensive than other options (though some costs may be tax deductible).
Plan With Purpose
Even though retirement may seem far away, saving now is critical to living the life you want and building a sustainable exit plan. Select a plan that works for your company now and that you see growing with you.
Remember that offering competitive retirement plans to employees is a smart way to attract and retain top talent. Do your research to identify the top benefits you’d like to have in your retirement plan, and if the plan you choose doesn’t work out, it’s okay! You can always change it if needed.
Craig Toberman is the Founder of Toberman Wealth – a fee-only financial advisor based in St. Louis. He assists families and businesses with strategic financial planning and long-term wealth management. He has over a decade of experience in financial services and has crafted custom financial plans for hundreds of families and businesses.
Craig received a Bachelor of Science (B.S.) degree in Agricultural and Consumer Economics from the University of Illinois and a Master of Business Administration (M.B.A.) degree in Finance from Saint Louis University. He is a Certified Financial Planner (CFP), Chartered Financial Analyst (CFA) charterholder, and Certified Public Accountant (CPA).
Craig is a member of the National Association of Personal Financial Advisors (NAPFA), Fee-Only Network, and XY Planning Network.
Craig lives in the greater St. Louis area with his wife, Ally and son, Hank.