Tags: , , , , ,

SEP, SIMPLE or 401(k): Which Retirement Plan Is Best for Your Small Business?

2015-08-18

Minyang Jiang

Updated August 8, 2022

As the owner of a small business, you’re used to juggling a lot of responsibilities — everything from drafting business plans to creating budgets. So its no surprise that you’ll be the one to choose which retirement plan you provide for your employees.

There are many types of retirement plans to choose from, and regardless of whether you’re a sole proprietor or have 100 employees, there is a plan that will work for your small business. Many owners of small businesses choose a 401(k) plan because it’s the option most people are familiar with. However, this may not be the best option you.

Why Should Your Small Business Have a Retirement Plan?

The main reasons you should set up a retirement plan for your small business is because it will help you and your employees secure their future, it helps minimize employee turnover, and because it can be declared as a business expense when you’re filing your taxes.

There are three different types of retirement plans that will work for small businesses, including SEP-IRA, SIMPLE IRA, and 401(k) plan. There are two types of 401(k) — one for self-employed individuals, and one for companies that have 100 employees or more. Since we are discussing small businesses, we will not be discussing the second 401(k) because it’s not suitable for businesses that have about 10 employees or less.

Each one of these retirement plans is different, and what they cover varies. In order to choose the right plan for your small business, you’ll need to understand what each one offers and match them with the needs of your business and employees. If you’ve been using a retirement plan that doesn’t fulfill your business needs, you may be losing out on tax benefits or even offering sub-par employee contributions.

Traditional Retirement Plans for Small Business 

We’ve all heard of the 401(k) plan, but there are so many different retirement plans beyond the 401(k) that might be a better fit for you.

For instance, the number of employees that you have on payroll could play a role in which retirement plan you choose and whether you’re looking for a plan with simplicity or a plan to maximize your contributions.

Simple IRA

 This plan is great if you employ fewer than 100 people per year. With this plan, you can save up to $12,500 per year if you’re under 50, and $15,500 if you’re over 50. You can also make a Simple IRA plan available to your employees and contribute to their accounts as a benefit. However, if you use a Simple IRA, your options for additional retirement plans are limited.

SEP IRA

 Just like Simple IRAs, SEP IRAs are available to business owners and their employees, and are a popular option for small businesses with few employees. You can contribute up to 25 percent of your compensation, up to a maximum in 2016 of $53,000. With a SEP, you have up to the extended due date of your taxes to contribute for 2016.

Simple 401(k)

In most ways, Simple 401(k) plans are identical to Simple IRAs. However, with a Simple 401(k), an account holder can take a loan against the account balance, which is not allowed under a Simple IRA plan. Just a few small differences, but could make an impact on your finances if you did need a loan from your retirement plan.

Solo 401(k)

If you don’t have any employees, you might want to consider a Solo 401(k). This plan offers a higher limit for savings than a Simple IRA – up to $18,000 a year as your 401(k) contribution portion. You can also have your business make a tax-deductible contribution on your behalf of up to 25 percent of your compensation, with a ceiling of $53,000. If you’re over 50, you can make a catch-up contribution for $6,000.

One last option to consider if you are looking for higher contribution limits is a Defined Benefit Plan. These plans traditionally work best in small companies, under 50 employees, where there are income and age gaps between the owner and his/her employees. Defined Benefit Plans involve actuaries that number crunch to find the exact contribution limit for your business in any given year.

Consider Alternatives for Your Retirement Plan:

If the idea of setting up a retirement plan doesn’t get you all excited, you might also consider a couple of options like potentially selling your business or cash-value life insurance, which can play a valuable role in your retirement funding.

There are no guarantees when you rely solely on selling your business to provide for retirement income. You’ll need to make sure that you have your business “sale-worthy” before you shop around for a buyer. Also, you should look into having an appraisal completed on your business to prep it for sale. As the old rule says, your business is only worth what someone else is willing to pay for it.

Life insurance can also play a valuable role in your retirement funding. Many people assume that life insurance is only good for your beneficiaries, but that’s only half the story. Cash value life insurance, with policies like Whole Life and Indexed Universal Life, allow cash value build up in the policy that can be used to assist in funding your retirement. The cash value can be accessed at retirement or prior to retirement. Working with a financial advisor will ensure that you get the best policy to meet your retirement needs.

Whichever retirement option you choose, the end of the year marks a great time to set up and start funding your plan. Don’t rely on your business alone to provide enough cash to fund your retirement. Starting today will allow your retirement portfolio the chance to compound over many years, which means more opportunity for greater returns for your future.

Choosing the Right Retirement Plan for Your Small Business

As you take each plan into consideration, always keep your priorities in mind and look into what the trade-offs are. If the only people in your business are you and your business partner, you should consider a Self-Employed 401(k) in order to get the highest contribution limitations possible. If you have multiple employees, you will need to choose either the SEP-IRA retirement plan or SIMPLE IRA retirement plan, both of which cover your employees. The main difference between the two is that you would fund SEP retirement funds on your own, while SIMPLE would allow you and your employees to contribute.

Small business owners who know what they are looking for in a retirement plan may find it much easier to choose an appropriate plan for their company. If employee contribution or ease of administration is important, your choice should reflect that. Knowing what you need ahead of time is essential to choosing a plan because they all have their advantages and disadvantages.