Small Business Retirement Plans: What You Need to Know

By Robert Bartley, CPA, CFP™

As a small business owner, you might be considering whether to establish a small business retirement plan. Over the past several decades, it has become clear that Americans need to save for their own retirement, as Social Security benefits are unlikely to completely cover their financial needs in later years. A comfortable retirement will likely require 80 percent of pretax income, and an average retirement is likely to last several decades. 

A retirement plan that supports both you and your employees in achieving retirement goals can make all the difference. However, shopping for your company’s retirement plan is about more than just the plan’s benefits to you, personally, and your employees. Different retirement plans offer potential benefits and drawbacks for your company. Both need to be assessed prudently.

Let’s look at the benefits retirement plans offer to your employees, your business, and you.

Retirement plans offer employees the chance to save for their retirement. Research has shown that this benefit is highly important to employees. In fact, a large majority would rather have robust benefits like retirement plans rather than salary increases. 

When existing employees look for a new job, it may be because they think their benefits package is lacking. And if you’re having difficulty attracting top talent, it could be that your benefits package comes up short compared to your competition. 

Offering a prized benefit can therefore increase your retention rates and make your small business more competitive in attracting top performers. Both can drive improvements in productivity and decrease your recruitment and training costs.

Employer-sponsored plans offer employees many advantages, such as pre-tax contributions that lower their annual tax burden and tax-deferred appreciation (dividends, interest and capital gains) on their contributions over time. Traditional retirement plans are taxed only when the funds are withdrawn in retirement.

Finally, small business retirement plans can offer considerable benefits for you as a business owner, for several reasons. First, of course, owners work in the company and are thus entitled to benefit from the plan just as employees do. If you make pre-tax contributions, your overall personal tax burden for the year will be lowered, and you’ll be taking steps toward a comfortable retirement. Second, you enjoy the same tax-deferred growth of interest, dividends, and capital gains as your employees, until you withdraw the funds in retirement. 

As a small business owner, you may also find that you are able to make higher contributions through an employer-sponsored plan than a self-directed plan. For example, the maximum contribution for a self-directed individual IRA is currently $6,000 per year (with an additional $1,000 in catch-up contributions for those 50 years old or older). Moreover, some retirement plans offer add-ons like profit sharing, which can be used to increase contributions to business owners based on their higher salary, tenure, and age.

If you want to maximize your own contributions and tax savings at a higher level, you need to choose the right plan.

Multiple options for small business retirement plans exist. It’s important to focus on four factors when deciding which to choose: 

• Your business’ size and demographics – How big is your company? Do you expect growth? What’s the average age of your employees?
• Your business’ cash flow – Do you need flexibility to minimize employer contributions in lean years and maximize contributions in productive years?
• Your personal goals – Where are you in your retirement planning? Do you need a plan with high contribution limits to retire early or catch up on contributions?
• Your business goals – What’s your motivation for offering a small business retirement plan? How much of your resources are you willing to dedicate to meeting these goals?

Here is a brief overview of small business retirement plan options and key considerations concerning these factors for each:

Simplified Employee Pension (SEP) IRA

• Business size: Any, including a sole proprietorship
• Contributions: Employer contributions only
• Contribution limits: Up to 25% of annual compensation
• Vesting: Immediately 100% vested
• Advantages:
• Manage cash flow – SEP IRA contributions are not required every year. You can vary the amounts according to your cash flow or even skip years.
• Simple and inexpensive
• No annual filing for employer

Savings Incentive Match Plan for Employees (SIMPLE) IRA

• Business size: Less than 100 employees
• Contributions: Employers and employees
• Employers must either match employee contributions by 100% up to 3% of employee compensation or contribute 2% of all eligible employee compensation.
• Contribution limits: $13,500, with a $3,000 catch-up contribution for those 50 and over
• Vesting: Immediately 100% vested
• Advantages:
• Employees can contribute to their own account like a 401(k)
• Simple – little paperwork or administration required

Payroll Deduction IRA

• Business size: Any
• Contributions: Employee via payroll deduction
• Contribution limits: $6,000, with a $1,000 catch-up contribution for those 50 and older
• Vesting: Immediately 100% vested
• Advantages: 
• Minimal employer involvement

Solo 401(k) 

• Business size: Sole proprietorship or partnership
• This plan would not be appropriate for businesses that plan to grow and acquire employees.
• Contributions: Employer (business match) and employees (as salary reductions)
• Contribution limits: $19,500 of your earned income as a self-employed person plus a $6,000 catch up contribution if you’re 50 or older
• Or 25% of your compensation of up to $57,000
• Advantages:
• The chief benefit of a Solo 401(k) is that participants can maximize contributions and tax savings as both a worker and an employer without the cost of contributing to multiple employee accounts. 
• Administrative burdens and costs are minimal.

Safe Harbor 401(k)

• Business size: Any
• Contributions: Employee (as salary reductions) and employer
• Employer must make agreed upon matching contributions or 3% contribution to all eligible employees. 
• Advantages:
• No annual discrimination testing
• High contribution limits favor highly compensated employees (like the business owner)

Traditional 401(k)

• Business size: Any, but usually not best for companies with less than 20 employees
• Contributions: Employee (as salary reductions) and sometimes employer
• Vesting: Employee contributions are immediately 100% vested; employer contributions may vest over time
• Advantages:
• Flexible employer contributions not mandated to a certain percentage of employee compensation. 

While it’s entirely reasonable to think about your personal advantages when considering small business retirement plans, retirement plan shopping is also very different as an employer than as an employee.

As an employer, you need to think about the costs and benefits to your business as well as the value offered to your employees.

In addition to the four considerations outlined above, you also need to consider the following factors:

Implementation

How easy is it to set up a given plan? The plan set-up includes not only choosing the more advantageous plan, but establishing, operating, and potentially plans for terminating a plan.

The establishment, for example, includes generating a written plan, setting up a trust for the assets, and more. Operating the plan includes managing the assets, providing information to employees about the plan, distributing the assets and more.

Consider the IRS’s requirements, such as the Form 5500, as well as payroll deduction, reporting and disclosure, and other human resources-related administrative paperwork. 

If there are hurdles for some plans, consider whether solutions such as hiring a professional exist. Small business financial advisors can offer streamlined solutions that provide multiple benefits, reduce small business liability, and minimize or erase drawbacks. 

Weigh ease of implementation with other business benefits. Never let potential hurdles deter you from choosing a plan that may offer more flexibility or tax advantages later on. 

Taxes 

Employers need to be thinking not just about how employee contributions and withdrawals are taxed, but also how their matching contributions will provide tax breaks for the business.

At the same time, don’t get too hung up on tax breaks. Calculate how much you’ll actually be saving versus how much you’ll be spending. 

Expenses and fees 

Each activity (choosing, establishing, operating and terminating) may come with associated costs. It’s prudent to discuss these with your plan’s advisors before making a final decision. 

It’s also very important to utilize your advisors to help your business avoid fees. Owners who overcontribute to a retirement plan in a given year, for example, can receive a tax penalty for excess contributions from the IRS. 

On the other hand, bear in mind that there is a tax credit available to small businesses that offsets the cost of starting a retirement plan and assists with up to three years’ worth of costs.

Flexibility

Employers should also consider flexibility when choosing a small business retirement plan. Will you be able to change the plan offering down the road, for example, as your company grows or circumstances change? 

You also need to think about what happens to an account if an employee leaves the company. The administrative work associated with an employee leaving can be significant.  

Vesting 

Vesting can be a helpful tool to increase employee tenures at your company and encourage retention.

Leverage this tool especially when your business has an intensive onboarding process that is expensive to repeat.

Click here to read more about what questions small business owners should ask themselves regarding retirement plans.

Case Study 1

John runs a small business where he is the only employee. Because he can afford to contribute 25% or less of his net profits or salary, he chooses a SEP IRA, accepting its lower contribution limits in order to take advantage of its simplicity. 

John uses contractors, but he is absolutely sure that these individuals should not and could not be recharacterized as employees per IRS rules. He confirmed this information with a financial professional because he knows that, if his contractors should be employees and he chooses a SEP IRA, he will owe the same percentage contribution that he paid on his wages or income to each contractor-turned-employee. That would be a bill that most businesses could not afford or that would put them at a competitive disadvantage.

Case Study 2

Sam owns an S corporation and is the only employee. He pays himself a small salary and receives substantial profits as dividends (caution, review the IRS’ reasonable compensation rules). He is debating between a SIMPLE IRA or Solo 401(k).

Because he does not have employees, he is not concerned about needing to match their contributions dollar for dollar under the SIMPLE IRA. Also, he is attracted to the SIMPLE IRA’s administrative simplicity. 

The Solo 401(k), on the other hand, is designed specifically for businesses like his. Plus, it offers high contribution limits that he can use his substantial profits to fund.

Both a SIMPLE IRA or Solo 401(k) could be a good fit for Sam.  

Case Study 3

Mary runs a small business with 40 to 50 employees. Depending on her cash flow and goals to recruit and retain employees, her most logical choices are SIMPLE IRA or 401(k). 

The SIMPLE IRA offers enough simplicity that she might be able to manage the plan internally via her Human Resources Specialist. However, she is interested not only in using a retirement plan to attract top talent, but also to retain her best employees. Consequently, the opportunity to vest employer contributions over time and reward longer tenured employees via a 401(k) is very appealing. 

Ultimately, Mary decides to pursue a 401(k) coupled with a profit sharing plan to maximize employee retention without breaking the bank. (Interested? Learn more in our eBook Profit Sharing: The Small Business 401(k) Tax Saving Secret.)

Retirement plans can benefit your employees, your business, and you. But as you can see, choosing among the options is complicated. Not only that, but for many small business owners, business and personal goals are interrelated. You require financial advice that understands this fact.

Robert Bartley, the founder and owner of Bartley Financial, grew up working many hours at his family’s restaurant, saved the money he earned, and started to invest. He felt he wasn’t getting the service he needed from his CPA, who lacked an aptitude for suggesting creative solutions. In fact, the more involved he became in his family’s business, the more he realized that, behind the scenes, critical information about the business was ending up in data silos, headed by financial and law professionals unwilling or incapable of coordinating with one another. Convinced that there had to be a better way to manage his personal and family business’ finances, he went to school and pursued the professional designations of CPA and CFP. 

Now, Robert uses his personal business experience and financial acumen to guide other business owners in Massachusetts and New Hampshire toward their most successful futures. The Bartley Financial team (which includes two CPAs) coordinates your business and personal goals and, in the process, enhances your business’ attractiveness to employees, improves its tax and cash flow strategies, tackles your company’s administrative needs, and coordinates a comprehensive approach with your business’ other financial professionals. 

Finally, Bartley Financial is a fee-only fiduciary. Fiduciaries are the only professional financial advisors mandated to put your and your business’s financial needs ahead of their own. Bartley’s fee-only structure ensures that your costs are forecastable and unencumbered by commissions or other hidden, fluctuating and unpredictable charges. You can be sure that Bartley advisors will have top notch customer service at the top of their priority lists.

Start your small business retirement plan journey today.