As a small business owner, hiring and keeping the right employees is important to your business. Retirement plans can be a valuable tool in attracting those employees and offering them a way to plan for their future. Whether it’s an Individual 401(k), a SIMPLE IRA, a SEP IRA, or a Safe Harbor 401(k), starting a small business retirement plan might be a step in the right direction.
What Are Individual 401(K) Plans?
As a small business owner, you may be able to have retirement benefits similar to those offered by large companies. If you and your spouse operate a small business without any employees, a simplified 401(k), called an Individual 401(k) Plan, may be a good option to help you work toward your retirement goals.
What Are the Benefits of an Individual 401(K) Plan for Business Owners?
- This type of plan may allow the owner and their spouse to shelter more income from taxes than other types of retirement plans allow.
- The business owner may be allowed to contribute greater amounts of their income to this type of plan versus other business retirement plan options.
- Contributions to the plan may be tax-deductible by the business.
- The business owner may borrow a portion of the account balance through a loan provision in the event of a hardship situation.
- Contributions to the plan are flexible and may include pre-tax elective deferrals, after-tax Designated Roth Contributions, discretionary or profit sharing, and rollover contributions.
- The owner may contribute up to 25% of their eligible income to the plan as a discretionary or profit sharing contribution. If self-employed, see IRS publication number 560 for figuring your allowable contribution.
- Elective deferral limits are adjusted periodically by the Internal Revenue Service (IRS), including the additional elective deferral amount for participants aged 50 or older.
What Are the Eligibility Requirements for Individual 401(k) Plans?
- An Individual 401(k) plan is available for businesses established as a sole proprietorship, partnership, limited liability company (LLC), or incorporated, including a Subchapter S corporation.
- Businesses determined to be part of a controlled group of businesses are not eligible.
- The deadline to establish a plan is by the last day of the fiscal year. For a calendar year business, this deadline is December 31st.
What is a Safe Harbor 401(k) Plan?
A Safe Harbor 401(k) Plan lets an employer offer a retirement plan regardless of salary. Generally it allows participants, including the business owners, to set more money aside than other types of retirement plans, which may have lower limits on allowed annual contributions. The Internal Revenue Code - and related regulations - allows for a Safe Harbor 401(k) plan not to discriminate against employees regardless of their income, even if the owner is the only employee contributing.
This plan allows eligible employees to contribute part of their salary, either pre-tax or after-tax as a Designated Roth Contribution. To satisfy Safe Harbor requirements, the employer is required to make either a matching or a non-elective contribution for all eligible employees.
The first requirement for a Safe Harbor 401(k) plan is that all eligible employees be allowed to participate.
An eligible employee is defined as someone who:
- has reached the age of 21,
- has at least one year of service, and
- has worked at least 1,000 hours in the year beginning with the date of hire.
An employer can make the plan more inclusive, for example, by covering younger employees or allowing employees with less than one year of service to participate.
What Are the Requirements for a Safe Harbor 401(k) Plan?
- Employer contributions - An employer is required to make a contribution to Safe Harbor 401(k) plans. The employer can do this by:
- Contributing a minimum of 3% of the compensation for eligible employees.
- Or, the employer can match the salary deferral contributions of all eligible employees.
- An example of this would be, if an eligible employee defers 5% of their wage (i.e., compensation), then the employer is required to make a matching contribution of 4% of the employee's compensation. This is built from the basic formula where:
- The employer contributes 100% of the salary deferral contributions that represent the first 3% of compensation.
- Plus an additional 50% of the salary deferral contributions that represent the next 2% of compensation.
- 100% vesting of the required employer contribution - The required Safe Harbor employer contribution is 100% vested immediately. Employees may take that money when they leave the business, no matter how long they have worked there.
- Annual notice to participants - Each year, the employer must provide a notice that explains Safe Harbor contributions and how the employer will satisfy those requirements.
- Establishment deadline - A new plan must be established by October 1 of the applicable year (assuming a calendar year plan).
What is a SIMPLE IRA Plan?
A Savings Incentive Match Plan for Employees, better known as the SIMPLE IRA, is a relatively easy way for a small business to add a retirement plan to their employee benefits.
How Does a SIMPLE IRA for Employees Work?
- Each eligible employee sets up a SIMPLE IRA and may choose to make deferrals before taxes from their paychecks. Employers may make a non-elective payment of 2% of compensation to each eligible employee on this plan. Or, the employer may match individual contributions up to 3% of compensation, for each employee, for the year. All employees must receive the same percentage of compensation for either the employer-non-elective or employer-matching contribution. The employer may change the percentage from year to year, but certain restrictions do apply.
- Participants are immediately 100% vested in the account value, meaning all funds are the eligible employees from when they are deposited.
- As the employer, your contributions may be tax deductible.
- The participating employees don't have to pay taxes on the income they contribute, either; however, employees generally owe taxes if they take withdrawals.
- Investment earnings made by the employees will compound tax-deferred until they begin to make withdrawals.
Who is Eligible for a SIMPLE IRA?
- Eligible employees must have received at least $5,000 in compensation from the business during any two years before the current year, and they are reasonably expected to earn at least $5,000 in the current year. An employer can set less restrictive requirements (for example, allowing all employees to participate, even those making less than $5,000), but it can't make more restrictions.
- This plan is for businesses with 100 or fewer employees. If the business grows and the employer hires more than 100 people, the plan can continue for two more years before expiring permanently.
What is a Simplified Employee Pension Plan, or SEP IRA
The Simplified Employee Pension Plan, or SEP IRA, is a small-business retirement plan that's easy to set up. Eligible employees establish SEP IRAs, to which tax-deductible contributions are made only by the employer. The contribution percentage can vary each year, from 0-25% of compensation. The same percentage of compensation must be contributed for all eligible participants, including the owner-employee. Employer contributions to an SEP IRA in 2019 can't exceed the lesser of 25% of the employees compensation or $55,00.
- A SEP plan must be available to all employees who are at least 21 years old, who have performed services for the employer for at least three of the preceding five years, and has received at least $600 in compensation from the employer.
- Employers have the option to use less restrictive participation requirements.
The employer can generally deduct all of the contributions made to the plan, subject to the lesser of employer contributions or 25% of compensation (limited to $280,000 per participant in 2019) paid to the participant, not to exceed $56,000 per participant. It is not considered to be taxable income to the employees (although employees will owe taxes when they take withdrawals from their accounts). Any investment earnings are tax-deferred until withdrawal, too.
The SEP plan is a tax-deductible way for small-business owners to attract and retain employees while also saving for their own retirement; after all, the owner is generally an eligible participant.
Offering retirement plans is a great way to attract and retain employees. As a business owner, you have many options. Discover more retirement plan options for small businesses.