Small business owners are faced with the challenge of making decisions for their business and employees daily. One of these challenges can be how one saves for retirement, reduce taxes, as well as offer benefits to attract and retain talented employees. Depending on the stage of your business, there are multiple options, but I will review the most common retirement plans – Simplified Employee Pension (SEP) IRA, Individual/Solo 401 (k), Savings Incentive Match Plan for Employees (SIMPLE) IRA, and 401 (k) /403 (b).
A SEP IRA provides business owners the ability to contribute into a retirement plan on behalf of their employees. SEP IRAs are solo funded by the employer, which means it doesn’t allow for employee contributions. The percentage of salary the employer chooses to contribute to themselves, would also need to equally be contributed to any employees. For this reason, I generally recommend SEP IRAs for self-employed individual with no employees (e.g. real estate agent, 1099 contractor, etc.). For 2019, the contributions cannot exceed the lesser of 25% of compensation or $56,000.
New to the retirement plan world is the Individual 401 (k). Similar to SEP IRAs, Individual 401 (k)s are recommended for self-employed individuals or family owned businesses (including spouses and children only). There are two key differences from the SEP IRA, first is the loan provision allowed under the 401 (k) platform. If a distribution is needed prior to age 59 ½, you can loan funds from the plan rather than taking a withdrawal. Since a loan is not considered a withdrawal, there are no taxes or penalties on the distribution. The second difference is the ability for employee contributions. For 2019, employees can contribute 100% of compensation up to $19,000 ($25,000 if age 50 or over). The employer can match up to 25% of compensation for a total contribution of $56,000, which includes the employee’s contributions.
If your business has more employees than just yourself or immediate family but less than 100, the SIMPLE IRA is easy and inexpensive to establish and operate. SIMPLE IRAs allow for employee contributions as well as an employer match. For 2019, a SIMPLE IRA allows for the employees to contribute up to $13,000 ($16,000 if age 50 or over). The employer is required to contribute annually either by a 2% non-elective match (no employee contributions required) or up to a 3% match of compensation. From an employer perspective, one of the negatives of the match is it is 100% vested, which means the employee retains the funds even if they choose to leave the company.
When a company has more than 100 employees or if the business owner prefers higher contribution amounts, then a 401 (k) or 403 (b) can be a great option. In most cases, a 401 (k) is an option for for-profit companies and a 403 (b) is for not-for-profit companies (schools, hospitals, etc.). A 401 (k) plan is more complex than a SIMPLE IRA due to tax filing requirements (Form 5500), top heavy testing, and higher administrative fees. However, a 401 (k) plan allows for higher employee contributions limits, loan provisions, and vesting schedule for employer contributions. For 2019, an employee can contribution 100% of compensation up to$19,000 ($25,000 if age 50 or above). The employer can match up to 25% of compensation for a total contribution of $56,000, which includes the employee’s contributions. The benefit of a vesting schedule is ability to maintain control of the employer match if the employee chooses to leave the company. A common vesting schedule is a 5-year graded, which means 20% per year of the employer’s match becomes the employee’s funds. For example, if an employee left after three years of service and the match has been $1,000 over that period, the employee would maintain $600 and the employer retains the remaining $400.
As a fellow business owner, I am trying to prepare for the future while running my day to day operations. Understanding the short and long-term benefits of a retirement plan can help build financial independence outside of your business. If you have a retirement plan or are considering one, please contact me to discuss which option makes the most sense for your business and personal goals.
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St Louis Park, MN 55446
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