How to Choose the Right Small Business Retirement Plan
Here are the pros and cons of various alternatives
Seven years ago, software developer Steve Silberberg, of Hull, Mass., left his job at a financial services firm to launch Fitpackers, a company that hosts local guided backpacking excursions. Today he describes his quality of life as “incredible.” But even with a full roster of trips and a few part-time employees, there’s one thing the 50-year-old entrepreneur doesn’t have: a retirement fund.
“My accountant told me I should put some money in an IRA, and I did for one year," Silberberg says. "But I haven’t done it since then because my income has been a lot lower since starting the business.”
Many small business owners are wholly focused on the day-to-day running of their companies. Even so, they need to set aside some earnings for later in life, says Kendall Storch, a principal of Longfellow Advisors, a Boston-based employee benefits and financial advisory firm.
To help you choose the right type of small business retirement plan for you, below is a breakdown of the four main alternatives sold by banks, brokers and mutual funds: A SEP-IRA (SEP stands for Simplified Employee Pension), a SIMPLE IRA (SIMPLE stands for Savings Incentive Match Plan for Employees), a Solo 401(k) and a SIMPLE 401(k). For all but SEP-IRAs, your business can be a sole proprietorship, a partnership, a limited liability company or a corporation. Owners of limited liability companies or corporations can't set up SEP-IRAs.
In all cases, earnings grow tax-deferred until you make withdrawals in retirement, and you can fund 2011 retirement plans as late as April 17, 2012 (or later, if you get a filing extension from the IRS). In most cases, the cost of opening and adminstering the plans is pretty small. The website 401khelpcenter.com has a helpful free directory of firms that sell retirement plans to small business owners.
What it is: A tax-deductible retirement plan that’s similar to a traditional IRA. There is no limit to the number of employees you can have with an SEP-IRA.
How much you can put in: For 2011 tax returns, you can contribute up to 25 percent of your compensation or $49,000, whichever was less. For 2012, the contribution dollar limit rises to $50,000.
Deadline to set one up: The due date of the employer’s tax return, including extensions.
Advantages: SEP-IRAs generally have low administrative costs (they often have no initial setup or annual fees), involve little paperwork and don’t require you to contribute to them every year.
Disadvantage: If you have employees, you generally must also fund SEP-IRAs for them, putting in the same percentage of their salary as you do for your account.
Best suited for: Small business owners with no employees, or owners who want to put money into their employees' retirement accounts.
What it is: A retirement plan for small business owners with 100 or fewer employees. Contributions are pre-tax and taken directly out of employee paychecks, the way they are with 401(k) plans.
How much you can put in: Up to 100 percent of compensation, or $11,500, whichever is less ($14,000 if you are 50 or older). You must contribute to employee accounts either by matching contributions of up to 3 percent of compensation for employees who invest in the plan, or by giving each employee an amount equal to 2 percent of his or her compensation.
Deadline to set one up: Oct. 1.
Advantages: You don’t have to fund your employees’ accounts alone, the way you must with a SEP-IRA; employees can contribute to their accounts.
Disadvantages: You’ll pay higher administration fees than with a SEP-IRA. Fidelity, for example, charges small business owners $350 a year or $25 per participant.
Best suited for: Small business owners with employees.
What it is: Sometimes called a self-employed 401(k) or individual 401(k), this retirement plan takes pre-tax contributions directly out of paychecks. It’s for self-employed people with no employees other than a spouse.
How much you can put in: You can make an employer's profit sharing contribution of up to 25 percent of your compensation plus an employee's contribution of up to $16,500 in 2011, and $17,000 in 2012. If you're 50 or older, you can add a "catch-up" contribution of up to $5,500 each year to the employee's contributions. But your total contribution can't exceed $49,000 for 2011 or $50,000 for 2012, not including the catch-up contribution amounts. If your spouse works with you, she or he can also put in the same amounts.
Deadline for setting one up: Dec. 31.
Advantages: You’re allowed to contribute more money to a Solo 401(k) than to other self-employment retirement plans. You (and your spouse if you work together) can also borrow against the money in your 401(k) account and make penalty-free withdrawals because of financial hardship.
Disadvantages: You must file a special IRS form annually if assets in the plan exceed $250,000.
Best suited for: Entrepreneurs who work alone or with their spouses.
What it is: Like a big employer’s 401(k), a SIMPLE 401(k) lets employees contribute through paycheck deductions. It’s available to businesses with 100 or fewer employees.
Advantages: You and your employees can borrow against the money in your 401(k) accounts and make penalty-free withdrawals due to financial hardship.
Disadvantages: You must make contributions for employees and file an annual tax form to the IRS.
Best suited for: Small business owners with employees.
Congress is working on legislation to make it easier for small businesses to offer retirement plans. If a law passes, I’ll tell you all about it.