Small Business Retirement Plans

Data updated 2-4-2020

The US Small Business Administration (SBA) released a report which highlighted a concern – only about a third of small or midsized business owners have an IRA. Even of this small majority, a further third were the only ones actually making contributions. 401(k) contributions are doing no better, with just 20% participating.

If you’re a business owner, you probably know better than anyone how difficult it is to set aside a fixed amount each time, but something is better than nothing at all. Here are a few investments options you can make use of to plan a comfortable retirement.

Below are the five small business retirement plans every small business owner must consider;

1. SEP IRAs

SEP IRA is a type of retirement plan that can be set up by employers, freelancers, sole proprietorships, partnerships and self-employed individuals. Contributions can only be made by the employer and are tax-deductible. Owner-employees contribute as both the employer and employee.

• SEP IRAs are ideal for businesses without any employees, or very few employees.
• Contribution Limits – The contribution limit for an SEP IRA account is 25% of the salary drawn, limited to a maximum of $56,000 and $57,000 in total contributions for 2019 and 2020 respectively.
• Note – This IRA is fairly easy to establish, cheap to administer and offered by most online brokering firms, benefits consultants and other major financial institutions.

2. Simple IRAs

Like the SEP IRA, a SIMPLE IRA retirement plan can also be set up by employers, freelancers, sole proprietorships, partnerships and self-employed individuals. Eligible employees can contribute a portion of their pretax income to this plan. This means taxes on investments are deferred till the time they are distributed.

• Simple IRAs are ideal for businesses with less than 100 employees.
• Contribution Limits – The maximum contribution you can make to your Simple IRA is $13,500 for 2020 and an additional $3,000 in catch-up contributions if you’re over 50 years old.
• Note – Simple IRAs are also easy to establish, and there are no compliance or testing issues to deal with. However, businesses with more than 100 employees are not permitted to use these accounts.

3. 401(k) Plans

401(k) plans are different from IRA accounts in many ways. Primarily, eligible employees can choose to make salary-deferral contributions (automatic salary reductions) on a pre or post tax basis. Employers can also make non-elective or matching contributions, or even add profit-sharing features. The earnings from the investments accrue tax-deferred.

• 401(k) plans are good for businesses that employ more than 50 people, but this varies depending on administration fees.
• Contribution Limits – The contribution limits for 401(k) plans are $63,500 and $62,000 for 2020 and 2019 respectively, and an additional $6,500 and $6,000 in catch-up contributions if you’re over 50 years old.
• Note – Administration fees for 401(k) plans can be in the range of several thousand dollars, but participants can take loans against their contributions, which makes them very attractive as an investment option.

4. Cash Balance Plans

Although cash balance pension plans are defined-benefit plans, they are maintained on the basis of an individual account, similar to defined-contribution plans. Employers credit a fixed percentage of a participant’s annual compensation to the account, along with interest charges.

• Cash balance plans are ideal for professional services firms, or businesses whose employees have a high discretionary income.
• Contribution Limits – The contribution limits are defined by the plan opted for and market rates.
• Note – In cash balance plans, the employee’s account is credited with a pay credit each year, and an additional interest credit. This is usually a fixed or variable rate that is linked to a particular index. Market rates do not define the payout – rather, it depends on the benefits defined by the plan. Additionally, administration fees can be quite high.

5. Profit-Sharing Plans

Instead of a fixed or index-linked benefits plan, employers can also offer a profit-sharing plan, which gives the participating employees a fixed share in the profits earned by the company. These are also known as DPSP or deferred profit sharing plans. Many employers favor these for the increased employee-involvement in the business’ growth

• Profit- sharing plans are ideal for most businesses with employees which are generating profits.
• Contribution Limits – 25 percent of total compensation or $56,000 & 57,000 whichever is less for 2019 and 2020.
• Note – Profit-sharing plans are limited to employer contributions, which are completely discretionary. The IRS form 5500 needs to be filled annually. These plans can also be offered alongside other retirement plans for employees of the company.