Whether you’re a start-up or an established business, retirement plans offer several benefits to small businesses. Retirement plans provide money saving opportunities and help take care of your employees, which is always a good strategy if you want to retain talent.

A small business owner’s options for retirement plans range from simple to complex plans. Small business retirement plans enable great flexibility for the owners and employees to fund for their future, but careful planning is necessary before execution.  Here are three plans to consider for your small business.

SIMPLE IRA
SIMPLE is an abbreviation for Savings Incentive Match Plan for Employees. As the acronym implies, SIMPLE plans are simple to setup and maintain. Small business owners wanting simplicity and minimal costs should first consider a SIMPLE IRA.

A SIMPLE IRA matches employee wage deferrals dollar-for-dollar up to 3%. This means that an employee wishing to participate in a SIMPLE IRA can invest a percentage of their earnings to grow for retirement and defer paying taxes on that investment.  Then, the small business owner would match the deferral up to 3% of employee wages. If an employee didn’t want to contribute any percentage of earnings, the employer is still required to make a 2% contribution to the employee’s retirement plan.

The SIMPLE IRA is a good plan for newly established businesses or start-ups just starting a retirement plan. “With this type of plan, a third-party administrator is not usually involved. The owner is able to do a lot on their own,” says Karin French, vice-president and owner of Noble-Davis Consulting, a firm specializing in retirement planning.

This plan, though, doesn’t offer much flexibility because of the lower deferral limits than other types of plans, a contribution limit of $12,500, and the owner can’t offer any other plans in conjunction with the SIMPLE IRA. Still, start-ups are not interested in flexibility, as they usually have other things to worry about, such as cash flow.

Key Takeaways

  • Easy to setup
  • Minimal fees for setup and maintenance
  • Must have 100 employees or less
  • Employer has to make contributions
  • Employee doesn’t have to make contributions
  • Contributions are tax deductible
  • Geared toward new or start-up businesses

401(k) Plan
Small business owners can forego the ease of implementation and maintenance of the SIMPLE IRA in favor of greater flexibility and higher deferral, or contribution, limits – and therefore, larger tax deductions. This plan is great for established small businesses.

Similar to the SIMPLE IRA, employees defer a portion of their wages. Because of the higher deferral limits (the contribution limit is $18,000), a 401(k) plan gives more generous tax savings opportunities when compared to the SIMPLE IRA. While small business owners have to contribute to an employee’s SIMPLE IRA plan regardless of if the employee contributes, they don’t have to contribute with a 401(k) plan. Small business owners have the option of matching employees’ contributions or merely maintaining the plan without matching.

Unlike the SIMPLE IRA, there are compliance requirements with this plan, such as disclosing plan information to employees, filing form 5500, and nondiscrimination rules. This plan requires more administration, and there are fees to maintain the plan. A business owner would need to consult with advisors when setting up and maintaining a 401(k) plan.

Key Takeaways:

  • Best for established small businesses
  • Higher deferral limits, which means more tax savings for employees and larger tax deductions for employers
  • Employer does not have to contribute to the plan
  • There are compliance requirements
  • More complex to setup and maintain
  • There are fees for setup and maintenance

Defined Benefit Plan
A defined benefit plan is significantly more complex and costly to maintain than the previously mentioned plans; but with more complexity and costs comes notably larger savings. With this type of plan, the employer is guaranteeing a pre-determined, or defined, amount of money every year after retirement. The defined amount is calculated by an actuary and is usually based on factors such as risk, the employee’s salary, and years of employment.

In this scenario, the employer bears all the risk. The employer makes most, if not all, of the contributions, and the employer’s contributions are required. The limits of a defined benefit plan are very high, which enables the owner to put in a lot more money and, therefore, deduct a lot more money and invest more into retirement.

According to French, this type of plan works well for professional service corporations such as doctors, lawyers, private medical practices, or the self-employed, where the owner is making a considerable amount of income and really wants to put away a substantial amount of money toward their retirement. A plan participant could receive a maximum of $210,000 annually.

Key Takeaways:

  • Great for doctors, lawyers, private medical practices, or the self-employed
  • The risk lies with the employer
  • Employer contributions are required
  • Contribution limits are higher than in any other type of plan
  • Higher contribution limits means greater tax deductions
  • Higher contribution limits means a substantial amount of money is invested into the retirement plan
  • Most complex and expensive type of plan to maintain

While 401(k) and defined benefit plans allow flexibility to small business owners wanting to increase contributions, their adoption, maintenance, and other compliance fees can be significant.  For example, each year the IRS requires a tax filing, and plan participants receive periodic reports of their plan balances.  Additionally, these plans often require complex calculations to maintain good standing with the IRS.  Contributions to owners or other highly compensated individuals may also be limited in certain circumstances.

Before adopting a retirement plan, a small business owner must evaluate the merits of each type of plan, consider its costs, and consult with their advisors.  Usually, the more simple the plan, the smaller the contributions allowed. A general rule of thumb to consider: as contributions rise, complexity, administrative costs, and other fees increase as well.