As a small business owner, selecting the right retirement plan is crucial for attracting and retaining talented employees while also allowing you to save tax-efficiently for your own retirement. With several options available, understanding the key differences can help you decide which plan aligns best with your goals and situation.
SEP IRA
A Simplified Employee Pension (SEP) IRA allows employers to contribute up to 25% of each eligible employee's compensation annually, up to a $66,000 cap in 2023. Contributions are flexible year-to-year based on profits.
Pros: Low operational costs, minimal administration, contributions are tax-deductible
Cons: No employee salary deferrals, all eligible staff must receive the same percentage contribution
Ideal for any business size - self-employed up to larger small businesses
No employee count limitations
Simple administration regardless of number of employees
SIMPLE IRA
The Savings Incentive Match Plan for Employees (SIMPLE) IRA combines employee salary deferrals up to $15,500 in 2023 with mandatory employer contributions as either a match (up to 3%) or 2% non-elective contribution.
Pros: Inexpensive to administer, allows employee deferrals
Cons: Employer contributions are required annually, lower contribution limits
Best suited for businesses with 100 or fewer employees
Avoids compliance testing required for larger 401(k) plans
Easy option for companies just starting out
401(k) Plan
This option enables employee salary deferrals up to $22,500 in 2023 ($30,000 if over 50), plus employer contributions. Total combined contributions cap at $66,000.
Pros: Higher contribution limits, substantial tax benefits, ability to add vesting schedules
Cons: Increased administration and compliance testing, costlier than IRA-based plans
Most ideal for small businesses with between 10-100 employees
Compliance testing is required once over 100 employees
Allows high contribution limits beneficial for larger staffs
Defined Benefit Plan
As a traditional pension, employer contributions fund a specified retirement benefit for employees, based on actuarial calculations. Allows very large contributions.
Pros: Massive contribution potential, assets grow tax-deferred
Cons: Significant ongoing costs and administration, required annual contributions
May work well for businesses with 10+ employees, mature owners/principals
Higher administration costs make funding easier with larger employee base
Enables maximizing contributions for owner nearing retirement
Solo 401(k)
For self-employed individuals or owner-only businesses. Functions similar to a traditional 401(k) but avoids the compliance testing and administration.
Pros: High contribution limits up to $66,000 for 2023, flexibility
Cons: Only suitable if no employees beyond owner/spouse
Perfect fit for self-employed individuals or owner-only businesses
No employees besides the owner and spouse allowed
Simple administration without compliance testing
Other possibilities include profit-sharing or cash balance plans. However, these additional options bring added complexity and regulatory requirements.
Profit-Sharing Plan
Can work for any sized small business
Most popular with companies having consistent profits to fund contributions
Greater complexity than SEP for self-employed/few employees
Cash Balance Plan
Designed for established small businesses with consistent profits/cash flow
Allows maximizing tax-deferred contributions for owner age 50+
Higher costs make more sense with larger employee count to spread expenses
So in essence, SEP/SIMPLE IRAs are best for smaller companies just starting out, while 401(k)s, defined benefit, or cash balance plans can maximize contributions for larger, mature small businesses able to handle the increased administrative costs.
The ideal retirement plan depends on factors like your business structure, employee count, cash flow needs, goals for contributions and tax deductions. Working closely with an accountant can help model out which retirement offering best positions your small business for future success.