Retirement Plan Options for Small Businesses
Submitted by MIRUS Financial Partners on June 9th, 2015Before I started my own firm, I didn’t need to think much about the contribution limits imposed on IRA and 401(k) accounts. But as a small business owner, I not only have options to several types of tax-deferred retirement options, I also have to think about what’s best for my business, and for employees.
If you own a small business, take a look at these tax-deferred retirement plans available to decide which is right for you.
SIMPLE IRA Retirement Plan Option
What is it:
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is for companies with 100 or fewer employees who earned $5,000 or more on payroll last year. In 2015, employees can contribute up to $12,500 to their account, plus a $3,000 catch-up contribution for employees age 50 and over. Contributions to a SIMPLE IRA count against the $17,500 limit for a 401(k). If you or your employees are contributing to more than one plan, this is important to keep in mind.
Set up:
It’s easy to set up a SIMPLE IRA plan. Using form 5304-SIMPLE from the IRS, you can allow your employees to choose where to invest their SIMPLE IRA contributions. SIMPLE IRAs are also inexpensive to set up, and even the nominal costs incurred may qualify as a tax deduction.
Employer contributions:
A SIMPLE IRA offers higher contribution limits than a Traditional or Roth IRA. As an employer, you are required to contribute: either 2 percent of an employee's total compensation or a matching contribution between 1 and 3 percent of total pay.
Tax Implications:
SIMPLE IRA contributions or matches are tax-deductible for business owners. Accounts have to be open by October 1 to qualify for employer tax benefits.
With the SIMPLE IRA, the penalty for early withdrawal is 10 percent and could be as high as 25 percent of the account's balance. Steep penalties may apply if your need to roll your money into a new account in the first two years.
SEP IRA as Retirement Plan Option
What is it:
The Simplified Employee Pension (SEP) is a retirement plan in which the employers make all the contributions to a SEP account. The amount the employer contributes is not set. Many businesses set up a SEP IRA so that the more a business profits, the more the employer contributes. This can be a good motivation for employees to help boost the company's bottom line.
And SEP can be terminated at any time without penalty. If your business grows beyond the point where a SEP IRA plan is a great idea, or if you let an employee go, the plan and contributions to it can be easily terminated.
Set up:
Setting up a SEP IRA is as easy as setting up a SIMPLE IRA. Fill out form 5305-SEP, let your employees know, and get started.
Employer contributions:
Employers make all the contributions to a SEP-IRA account, but employees don't have to make contributions, and contributions don't have to be a set amount or percentage. Unlike a traditional or Roth IRA, a SEP IRA lets you make fairly large contributions: the lesser of $53,000 (in 2015) or 25 percent of your net income. One of the more challenging characteristics of the SEP-IRA is that ALL employees must be included. Every employee who is eligible for this plan has to be included, which can make it expensive if you start growing your business.
Tax implications:
Any contributions you make to your employees' or your own SEP IRAs are tax-deductible as business expenses.
Solo (Individual) 401(k) as Retirement Plan Option
What is it:
The Solo 401(k) account is best for a self-employed individual or the owner of a very small business. Use a Solo 401(k) for yourself, and if your spouse works as your employee, you can contribute as an employee and as an employer. You can cap your contributions as an employee and then have your business contribute up to 20 percent of your total earnings.
Set up:
A Solo 401(k) isn't as complicated as some plans, but it is more complicated than the IRA options. You'll have to find a plan administrator to set it up.
Employer contributions:
You don't have to contribute a set amount to a Solo 401(k) each year, so you can contribute less if you have a tough year or more if you have a good year.
Tax implications:
If you make a contribution to this account as an employer, the contribution will be deductible as a business expense. You can set up a Solo 401(k) by December 31 to make contributions for that tax year all the way up to the April 15 filing deadline (plus extensions). This makes it a good way to shelter some of your income if you need to reduce your tax bill. Once there is at least $250,000 in your account, you'll have to report your benefits through IRS’ form 5500 annually.
Defined-Benefit Plan as Retirement Plan Option
What is it:
A defined-benefit plan can be a great way for small-business owners and the self-employed to save more for retirement than they would otherwise be able to save. You could use it to save more than $100,000 a year for retirement. This plan is a great way for business owners who consistently have substantial money available to save. Because a defined-benefit plan is so different from other retirement savings accounts, you can combine it with a Solo 401(k) or a SEP IRA to save more than $150,000 a year for retirement. You can withdraw only a set amount per year during retirement unless you roll the money into another retirement account.
Set up:
When you set up this plan, you're committed to funding it at a certain level to meet the eventual payout, even if your business has a bad year. When you set up this type of plan, you define your payouts at the start, so it’s important to ensure your business can handle the minimums, regardless of cash flow.
Employer contributions:
Defined-benefit plans are created for your entire company, so payouts depend on how long someone works for you. If you use this plan for your retirement, you'll have to offer it for your employees as well, which can get expensive. This is why defined-benefit plans have become less popular for larger businesses, but may be a good option for a solo operation.
Tax implications:
Defined-benefit plan contributions can be written off as business expenses, reducing your business income and personal income, which could decrease your tax rate and your tax bill.
With a little investigation, you’ll find there are many retirement options for small-business owners. It’s important to consider not only your personal goals but also about your goals for your business. Consider whether you'll stay small or scale-up, and whether you're prepared to offer retirement benefits to lots of employees. And remember that the details of these plans, including tax benefits, may change from year to year. As with any complicated financial issue, it’s important to consult a financial advisor before making any final decisions.
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Mark A. Vergenes is President of MIRUS Financial partners, 110 E. King St., Lancaster. Investment Advisor Representative offering securities and advisory services offered through Cetera Advisor Networks LLC., member FINRA/SIPC. He can be reached at 717-509-4521 or mark@mirusfinancialpartners.com Cetera is under separate ownership from any other named entity. MIRUS Financial Partners nor Cetera Advisor Networks LLC. give tax or legal advice. Opinions expressed are not intended as investment advice or to predict future performance. All information is believed to be from reliable sources; however we make no representations as to its completeness or accuracy.