How to Choose the Right Small Business Retirement Plan

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.