Small business owners have several options from which to choose when looking to establish a tax-advantaged retirement plan for themselves and their employees. Each type of small business retirement plan has its own unique advantages and disadvantages.

The cost and paperwork required to establish and maintain a traditional 401(k) plan is simply too much for most small businesses to handle. That’s where the SEP IRA, SIMPLE IRA, and Solo 401(k) can help. These plans are available to any type of business organization including a sole proprietorship, partnership, LLC, and corporation.

SEP IRA

The first type of retirement plan for small business is the SEP IRA. SEP IRA is an acronym for Simplified Employee Pension Individual Retirement Account.

Here are the basic facts about the SEP IRA:

• Max Employees: Unlimited
• Min Employees: 1 (self)
• Who can Contribute: Employer only
• Employee Annual Contribution Limit: Not applicable
• Employer Annual Contribution Limit: The lesser of: a) 25% of employee compensation, b) $68,000, or c) 25% of your business profit less one-half your self-employment tax if no employees
• No catch-up contributions, no Roth option

SIMPLE IRA

SIMPLE IRA stands for Savings Incentive Match PLan for Employees Individual Retirement Account.

Here are the basic facts about the SIMPLE IRA:

• Max Employees: 100
• Min Employees: 1 (self)
• Who can Contribute: Employer and employee
• Employee Annual Contribution Limit: $16,000 plus $3,500 catch-up for those age 50 and older
• Employer Annual Contribution Limit: The lesser of: 1) 3% of employee compensation, 2) 3% of your business profit less one-half your self-employment tax if no employees
• Employee + Employer Annual Contribution Limit: $23,000
• Penalty for early withdrawal is the steepest at 25% compared to 10% for the other plans

Solo 401(k)

Also known as an individual 401(k) or self-employed 401(k), the solo 401(k) is another option for small business owners.

Here are the basic facts about the solo 401(k):

• Max Employees: 2 (self and spouse)
• Min Employees: 1 (self)
• Who can Contribute: Employer and employee
• Employee Annual Contribution Limit: $23,000 plus $7,500 catch-up for those age 50 and older
• Employer Annual Contribution Limit: 25% of employee compensation
• Employee + Employer Annual Contribution Limit: $69,000 plus $7,500 catch-up for those age 50 and older
• Includes a Roth option

Retirement Plans for Small Business

These types of plans have many of the same rules as a traditional IRA. Employee contributions are made on a pre-tax basis meaning you can deduct your contributions from your taxable earnings in the year they are made. When distributions are taken in retirement, you owe tax on both your original contributions plus any investment earnings. There is a penalty for early withdrawal and you must begin taking required minimum distributions at age 72.

The contribution limits on these plans are cumulative, so there is no point in having more than one type of plan. In other words, you cannot contribute $68,000 to a SEP IRA and another $69,000 to a solo 401(k). 

The cumulative limits apply to all small business owners including those who are otherwise employed, i.e., individuals who operate a side-business. For example, if you contribute to the retirement plan at your “day job", your contributions to the retirement plan you’ve set up for your small business cannot exceed the overall limit. The IRS is like the eye in the sky, they know everything you’re doing. That said, you can contribute to both plans as long as you do not exceed the overall limit.

Unless you are an extreme do-it-yourselfer, you will need the assistance of a tax professional to establish a retirement plan for your small business.

Closing Time

The IRS is pretty generous with the contribution limits. At fifty grand a year, you can sock away a half million dollars in ten years. With regard to which type of plan to choose, there are a number of factors to consider. The contribution limits on a SIMPLE IRA are considerably less than either a SEP IRA or a solo 401(k). A SEP IRA has less paperwork than a solo 401(k), but if you have employees you have to give them the same percent of their salary as you give yourself. Another important factor to consider regarding a SEP IRA is the fact that your employees cannot contribute to their own plans.

It’s best to sit down with a calculator and run some numbers before you decide. It’s the only way to know for sure which plan is right for you. One of the ingredients is business profit, something unique to your situation. The accounting costs to set up and maintain the plan (or the hassle to do it yourself) should also be a consideration.

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