Small businesses can appeal to experienced and talented job applicants by offering simple, robust, and flexible retirement plans. Some plan types even come with tax advantages. In this article, we’ll discuss different small business retirement plan options and their benefits.

What are some retirement plan options for small businesses?

In the past, the high costs and administrative burdens of managing a traditional retirement plan was often too much for small companies. However, thanks to modern providers, 401(k) plans may be more affordable and accessible for small businesses and their employees. As a small business owner, some of your retirement plan options include:

• SEP-IRAs

• SIMPLE IRAs

• 401(k)s

• Defined Benefit Plans

Why set up a retirement plan for your business?

There are numerous reasons why a small business should offer a retirement plan. Retirement benefits can not only help your employees save for their future, they can help recruit and retain workers. Businesses may also qualify for tax credits by offering plans like a 401(k). For example, you may be eligible for the Retirement Plans Startup Costs Tax Credit, which offers qualifying businesses a credit to offset specific plan expenses. If you’re generous enough to offer an employee match, you may qualify for even more tax-deductions. This means you can simultaneously boost your bottom line—all while increasing the well-being of your employees.

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Small business retirement plans to consider

Small business owners should consider the retirement plans they offer through their business, whether they work alone in a sole proprietorship or have a number of employees. There are numerous plans and plan options to choose from—and the right one for your business depends on its structure, your business’s size, and how much money your business can afford to contribute. Self-employed workers should also consider the account that gives them the best benefits as both an employer and an employee. Let's review.

Simplified Employee Pension Plans (SEP-IRA)

Simplified Employee Pension Plans, or SEP-IRAs, are a simple retirement plan option for small businesses, self-employed workers, or freelancers. A key distinction is that employers (not employees) make all of the contributions to SEP-IRAs. They must make the same level of contribution for every employee. Small businesses, including sole proprietorships, S corporations, and partnerships can establish SEP-IRAs.

SEP-IRA contribution limits

SEP-IRA contribution limits can’t exceed $69,000 in 2024 ($66,000 for 2023) or 25% of the employee’s net income, whichever is less. To calculate your adjusted net self-employment income, first, take your gross income and subtract any SEP IRA contributions and business expenses. Then, subtract half of the amount you pay in self-employment tax. Because SEP-IRA contributions don’t overlap with IRA contributions, employees can still make the maximum allowable contributions to private IRAs. 

Benefits of a SEP-IRA

SEP-IRA plans may be ideal for small businesses with few employees who don’t want the hassle of paperwork of government filing. Operational costs for this type of plan are minimal, compared to those of a 401(k), as many SEP-IRAs do not require setup or annual maintenance fees. Not only are SEP-IRA contribution limits higher than IRAs and 401(k)s, but business owners can also take advantage of flexible funding. This means they can adjust contribution levels each year—or skip them altogether. Ultimately, SEP-IRA plans may save business owners on tax bills without significant planning.

What are the withdrawal rules for a Simplified Employee Pension plan?

Aside from its difference in contribution limits, SEP-IRA plans are similar to traditional IRAs. For example, participants may take distributions from a SEP-IRA at any time without proving a hardship. However, distributions taken before age 59 ½ may be subject to a 10% tax penalty plus any additional income tax liability. Finally, required Minimum Distributions (RMDs) begin at age 72 for SEP-IRA plans.

Savings Incentive Match Plan for Employees (SIMPLE) IRAs

Savings Incentive Match Plan for Employees (SIMPLE) IRAs are also designed for small businesses. Like SEP-IRAs, employers must make contributions. However, these contributions must happen every year and the limits are lower than SEP-IRAs.

SIMPLE IRA contribution limits

According to the IRS, employee contributes to a SIMPLE IRA cannot exceed $16,000 in 2024 (participants aged 50 or over can also make catch-up contributions of up to $3,500 in 2024). These contributions may include salary reduction contributions (the amount that an employee contributes from their salary) or employer contributions (including matching or nonelective contributions). If an employee has elective salary reductions under other plans throughout the year, the total amount of the salary reduction contributions they can make to all plans is limited to $23,000 in 2024.

Each year, companies must choose one of two contribution methods—and must inform their employees during the election period which method will be used. Below are the two types of SIMPLE IRA employer contributions:

1. 3% matching contribution. Companies may reduce this 3% limit to a lower percentage, no lower than 1%. Additionally, they may not lower this limit for more than two years out of the five-year period ending with the calendar year the reduction is effective.

2. 2% non-elective contribution. Under this option, employees don’t have to contribute to receive money.

SIMPLE IRA benefits for employers

SIMPLE-IRAs allow employers to offer meaningful retirement benefits without a lot of complications or hassle. They do not require non-discrimination nor top-heavy testing, making the plans easy for small businesses to administer. Additionally, SIMPLE-IRA plans are fairly straightforward to set up and have fewer guidelines compared to other qualified plans. However, employers are legally required to match employee contributions (unlike other qualified plans, which allow employers to choose if they offer a match).

SIMPLE IRA withdrawal rules

The beginning date for RMD for all IRAs, including SEPs and SIMPLE, is age 72. As a participant, you generally must pay income taxes on the amount you withdraw from a SIMPLE IRA. You may also be required to pay additional taxes: 

• A 10% tax is required if you withdraw under the age 59 1/2 unless you have a qualifying exception (in some situations, this tax increases to 25%).

• A 25% tax is required if you withdraw within two years from when you first participate in a SIMPLE IRA plan.

Can you have a SIMPLE IRA and a SEP IRA in the same year?

According to the IRS, if you are not the owner of your employer’s business, you can contribute the maximum to both SIMPLE IRA and SEP-IRA plans, as an employee’s contributions to a SEP plan are not reduced by contributions made to an employer’s SIMPLE IRA plan (whether by the employee or the employer). Technically, there’s no limit to the number of IRAs an individual may have. Instead, annual maximum contribution limits set limitations. For example, what you contribute to a SIMPLE IRA will reduce what you can contribute to other IRA accounts.

Traditional, SIMPLE, and Solo 401(k) Plans

401(k)s are a popular retirement account option that comes in three general varieties: 

1. Traditional 401(k) 

2. SIMPLE 401(k) 

3. Solo 401(k)  

Most businesses are eligible for 401(k) plans, but administrative fees and stringent requirements can make it difficult for small businesses to manage them alone. However, with the right plan provider, small businesses can offer 401(k) plans to their employees. 

Benefits of a 401(k) plan for small businesses

Small businesses may benefit from several tax advantages by offering a traditional 401(k) plan to their employees. For starters, eligible companies may be able to claim plan startup tax credits of up to $5,000, for three years, to cover the costs of starting a 401(k) plan. This can reduce the amount of taxes a business may owe. Small businesses may also qualify for deductions by offering an employee match and an additional tax credit by offering an auto-enrollment feature to their plan.

Savings Incentive Match Plan for Employees (SIMPLE) 401(k)s may be more advantageous than traditional 401(k)s for small businesses because employees are immediately vested, and employers don’t have to handle non-discrimination income tests. These plans are similar to SIMPLE-IRAs, but carry an additional benefit of allowing employees the option to take out loans against their accounts. 

Solo 401(k) plans provide self-employed individuals access to tax-advantaged savings that traditionally employed individuals have. While self-employed individuals must start filing paperwork once their account has more than $250,000, small business owners can realize even more benefits by having their spouses participate and looking for plan administrators that don’t charge setup and management fees.

401(k) Contribution Limits

Traditional 401(k) plans

In a 401(k) plan, employees contribute a portion of their salary to a range of investment options. Earnings from these investments are tax-deferred, meaning that employees pay taxes when the savings are withdrawn. Employees can contribute up to $23,000 to a 401(k) in 2024 (up from $22,500 for 2023). If age 50 or older, individuals can contribute an additional $7,500 in catch-up contributions in 2024 (for a total of $30,500). As an added benefit, some employees match a portion of an employee’s 401(k) contributions. 

Does an employer match count toward the 401(k) limit? In short, the answer is no. While employer matching contributions are not factored into an individual’s contribution limit, there are limitations, as set by the IRS, on total contributions to a 401(k) plan. The limit on total contributions from an employee and employer cannot exceed the lesser of either 100% of an employee’s salary or $69,000 (up from $66,000 in 2023).

SIMPLE 401(k) plans

(SIMPLE) 401(k) plans are similar to traditional 401(k)s but carry lower employee contribution limits, which makes them ideal for small businesses with employees that make $50,000 a year or less. The maximum amount employees may contribute to a SIMPLE 401(k) is $16,000 ($19,500 for those aged 50 or older) for 2024. Additionally, employers must match contributions of up to 3% of each employee’s pay or provide a non-elective contribution of 2% of each eligible employee’s pay.

Solo 401(k) Plans

Self-employed individuals can create solo 401(k) plans, or one-participant 401(k) plans, for themselves. Because the business owner is technically both the employee and employer in these business designs, contributions can be made in the following capacities:

• Elective deferrals up to 100% of compensation (known as “earned income” for self-employed individuals) up to the annual contribution limit of $23,000 in 2024 (or $30,500 in 2024 if age 50 or over)

• Employer nonelective contributions up to 25% of compensation

In 2024 contributions for solo 401(k) plans cannot exceed $69,000.

401(k) withdrawal rules

Participants in 401(k) plans must generally keep funds in their account until age 59 ½ unless they qualify for a penalty-free withdrawal or hardship withdrawal (Qualified Domestic Relations Order, or QDRO, rulings can also force a 401(k) withdrawal without penalty prior to 59 ½). Once a participant is retired and reaches this age, they may take out 401(k) distributions, either periodically or as a lump sum (periodic distribution often requires confirmation from the employer administrating the account). If an individual chooses to wait until after this age, the SECURE Act extended RMDs for 401(k) plans to age 72 (if the participant turns 70-years-old on July 1, 2019 or later).

These withdrawal requirements apply to all 401(k)s, including traditional, SIMPLE, and solo plans. However, a central feature of a SIMPLE 401(k) plan is that they carry an additional benefit of allowing employees the option to take out loans against their accounts. 

Defined benefit plans

Most employer-sponsored retirement plans fit into one of two major categories:

• Defined-benefit plans: Otherwise known as traditional pensions, these plans provide employees with a specific amount in retirement.

• Defined-contribution plans: Enable employees (and employers if they so choose) to contribute funds to a plan.

Defined-benefit plans are becoming increasingly rare in the private sector—and are being replaced in favor of defined-contribution plans. In March 2020, only 3% of private industry workers had access only to a defined benefit retirement plan, compared to 52% who had access only to a defined contribution plan.

What is the difference between defined benefit and defined contribution?

Defined benefit plans can have perks for employees, as employers assume the risks, file details with the government, and offer fixed benefits tied to annual salary and tenure. High-income professionals that can handle the administration costs can enjoy generous fixed benefits. Consultants, spouses of high-income earners, and other high-earning professionals can use these accounts to create robust estate plans and shelter profit from taxes. However, plans require an enrolled actuary who can file Form 5500 and determine funding levels.

In defined-contribution plans, the benefit is not known—the contribution is. Contributions come in a designated amount from the employee, who has a personal account within the plan and chooses investments. As investment results are unpredictable, the ultimate benefit at retirement is undefined. However, the employee owns the account itself and can withdraw or transfer funds within plan rules. 401(k) plans are among the most common types of defined-contribution plans and carry additional benefits for employees, including the fact that they’re tax-deferred, meaning that individuals defer paying taxes on income to a later date.

Setting up the right retirement plan for your business

No matter what retirement benefits plan is the right fit for your business, Human Interest is here to help. We offer affordable, streamlined 401(k)s and 403(b)s that make it easy to save for retirement. Contact us today for more information.