I love small businesses! I own one myself, and I can relate to what many of them go through. Many of my clients are small business owners.

Previously I wrote broadly about the various retirement accounts available (see article).  Now I want to dive a little deeper into the small business options and help others evaluate which might be best for them.

It seems like now more than ever, business owners get tripped up trying to decide which route to take for their retirement plan. The most common, and which I personally see most, are these three types: SEP, SIMPLE, or SOLO 401k. Here’s how they compare:

SEP IRA

What is it?

SEP stands for “Simplified Employee Pension”. They are widely used for owner-only businesses and those with just a few employees.

Key features:

No IRS filings to deal with

Easy to administer

Only the employer can contribute

For 2021, one can add as much as $58,000 (if salary warrants it)

When should you consider it?

For small business owners who want to avoid the startup and operating costs of a conventional retirement plan, the SEP is a great choice. They’d have the ability to supersize their savings, and get a tax deduction for these contributions made for them or other employees. Employees are not allowed to contribute – all additions are discretionary and made only by the employer.

Keep in mind the employer would have to contribute equally (on a percentage basis of salary) to all employee accounts, including their own. For example, if a three-man business earned salaries of $150k, $100k, and $90k, and the employer wanted to contribute 10% this year…they’d contribute $15k, $10k, and $9k respectively. Certain exclusions can be incorporated, like requiring an employee to have worked for the company in 3 of the past 5 years, for example.

SIMPLE IRA

What is it?

SIMPLE is the acronym for “Savings Investment Match Plan for Employees”. These plans are low cost, easy to administer, and used for businesses with 100 employees or less.

Key features:

Primarily funded with employee contributions (taken from salary)

The employer must contribute/match

Easy & economical plan to administer (compared to a traditional 401k)

For 2021, employees can contribute up to $13,500 ($3k more if age 50+)

No IRS filings due for this plan

When should you consider it?

As a business owner, this is a nice option for providing additional benefits to your employees. They would appreciate the plan contributions that the employer makes to the plan (2-3% of the employee salary). Also, it would serve as an incentive for them to save and stay with the company.

Keep in mind that employees under age 21 or making less than $5k annually can possibly be excluded from the plan, if that would be a deterrent. All employer contributions are tax-deductible as a business expense.

SOLO 401k

What is it?

Also referred to as an “Individual 401k”, “I-401k”, and “Individual K”, this is only available to self-employed individuals and business owner (and their spouse, if applicable). It can have no other employees.

Key features:

Many of the benefits of a traditional 401k plan

High contribution limits – for 2021, as much as $58k (add $6,500 more if age 50+)

Easy to administer

Flexible annual contributions

When should you consider it?

The I-401k should be a strong consideration for any individual business owner or self-employed person and their spouse. If you have other employees, you cannot go this route.

Provided you qualify and want to sock away good chunks of money, you’ll like the maximum you can put into the plan. Through a combination of salary deductions with profit-sharing contributions from the company, imagine putting $60k+ into a plan like this for tax-deferred growth. I’ve seen people open these plans who want to maximize their savings, and be able to add flexible amounts. And there is no annual commitment – having a down year in the business? No worries…no requirement to add anything.

Disclaimers (aka Final Thoughts)

Many rules go along with these plans, in addition to some of the highlights above. I tried to keep things…well, SIMPLE. There is an infinite number of resources available online as well as with the various financial firms who help set these up.

Second, there is no perfect plan for each specific business. I’ve seen several dentist and medical offices use SIMPLE plans, and the real estate industry using SEPs. That doesn’t mean that everyone should use them in that manner, there will be particular circumstances with every situation that you’d want to consider.

Last, as if the above 3 types of plans discussed today aren’t confusing enough for you…there are more options out there! Employers can start a traditional 401k, profit-sharing plans, or defined benefit plans, amongst others.

If you are in the market for this type of account, do your homework. Talk to a professional. Weigh out your options. If you don’t have one of these in place – but are considering it – it’s probably worth making it happen.

Brandon

 

Risk Disclosure: Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results.

This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The content is developed from sources believed to be providing accurate information; no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative use only.