By Liang Zhao, CPA, MSA, CMA, Senior Accountant, Falco Sult
As a small business owner or a sole proprietor, you have many more options when it comes to retirement plans compared to those of an employee. In addition to securing your future retirement, you can also receive the benefit of a business deduction for the retirement contributions made, and there are generally much higher contribution limits compared to traditional or Roth IRA accounts.
The following are a few of the most common retirement plans that are relatively easy to set up and maintain for small businesses:
Simplified Employee Pension (SEP) IRA
A SEP IRA plan is available for both sole proprietors and small business owners with any number of employees. The contribution is generally limited to the lesser of 25% of wages or self-employment income, or $56,000 for 2019.
With the generous limit, a SEP plan is generally the easiest way to contribute the most funds into a retirement account. However, employers with non-owner employees need to take into consideration the “non-discrimination” requirement when choosing a SEP plan.
If an owner chooses to make contributions for themselves, the business must also contribute to the SEP accounts for all employees based on the same percentage of compensation, if the other employees meet certain criteria. This non-discrimination clause requirement provides advantages for attracting potential talent, but it may also make the SEP plans quite costly for employers with significant compensation expenses to non-owner employees.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
A SIMPLE IRA plan is only available to employers with 100 or fewer employees. Under a SIMPLE IRA plan, employees can contribute up to 100% of eligible compensation through salary deferral, not to exceed $13,000 for 2019, with an additional $3,000 catch-up contribution available for those who are 50 or older.
Unlike SEP plans where employers can make discretionary non-discriminatory contributions, SIMPLE IRA plan employers must match employee deferral contributions based on either a) 100% match on the first 3% deferred (match may be reduced to 1% in 2 out of 5 years) or b) a 2% non-elective contribution on behalf of all eligible employees. Also, no additional employer contributions may be made.
If you are a small business owner who is seeking an option that provides your employees with the option to make pre-tax salary deferral contributions, SIMPLE IRA could be a good choice.
One-participant, or solo 401(k) Plan
A solo 401(k) plan is only available to sole proprietors and self-employed individuals with zero non-owner employees and offers the most generous contribution limit. A solo 401(k) plan offers the largest possible contributions because contributions can be made as both an employee and as an employer. As an employee, you can make elective deferrals of up to $19,000 for 2019. As an employer, you can make a profit-sharing contribution of up to 25% of compensation, or up to a maximum of $56,000 for 2019. For 2019, your total contributions as employer and employee cannot exceed $56,000. For those who are age 50 or older, the limit increases to $62,000.
The catch for the solo 401(k) plan is that unlike SEP and SIMPLE plans where there are no annual filing requirements, a solo-401(k) plan requires annual Form 5500 filing once the plan assets exceed $250,000. Despite this additional filing requirement, you may still find this option most appealing if you are the only employee of your business and are aiming to maximize your annual contributions.
If you would like to know more about these retirement options, or need help setting up a plan, please don’t hesitate to contact our office.