Not sure where to put your money?
Small business owners are constantly making decisions that affect not only their company’s bottom line, but their own livelihood as well. So, a common question they ask when talking about finances is, “What’s the best saving option to allow me to save for retirement and help save on taxes?”
A quick, easy way to put money aside while saving on taxes is to open some type of retirement plan. For the small business owner, there are several types of plans that can meet their needs. Some of the most common are a 401(k) plan, a SIMPLE IRA plan, or a SEP IRA plan. Any one of these three can help a small business owner meet the dual goals of savings and tax deferral.
A SIMPLE IRA plan is a way for a start-up type employer to offer their employees a retirement plan in a low cost manner, which enables their employees to make deferral contributions to the plan, though at limits lower than a 401(k) plan. The employer must make mandatory contributions, as defined in the statute, which can be either a flat percentage to employees across the board or a match of individual contributions at a higher rate.
A SEP IRA is another low cost way to start a retirement plan. One advantage, in addition to its very low administrative cost, is the ability for the plan to be set up after the end of the fiscal year. However, only the employer can make contributions to the plan and they must be uniform across the board. The employer contributions are not required for any given year. These contributions are made at the employer’s discretion and can be deposited in a lump sum after the end of the fiscal year.
There are a couple of disadvantages for SIMPLE IRA‘s and SEP IRA’s. Both plans include the requirement of immediate vesting for all employer money and neither allows for employees to take loans from their accounts.
A traditional 401(k) plan offers several advantages over SIMPLE IRA’s and SEP IRA’s when it comes to setting up a retirement plan. The employer enjoys much greater flexibility in the design of the plan, including eligibility requirements, vesting schedules, the ability for employees to take loans, allowing for Roth contributions and more flexible employer contribution options.
The traditional 401(k) plan provides a structure allowing both the owners and the employees to defer on a larger portion of their compensation affording them greater tax savings. A 401(k) plan is a type of profit sharing plan and can be configured to allow the employer to make discretionary profit sharing contributions in addition to employer matching contributions. A 401(k) plan may also allow the employer access to better investment choices with lower associated fee cost.
This added flexibility in plan design, along with potentially increased administrative costs, comes with additional rules and regulations. Among these, the plan must undergo discrimination testing, which may limit the amounts owners and other high earners may contribute.
For many employers these disadvantages are outweighed by the increased flexibility a 401(k) plan provides. These include the ability to offer employee loans, add Roth accounts, make discretionary employer contributions along with higher deferral and catch-up limits.
Kent Wright – Due Diligence and De-accumulation Analyst – firstname.lastname@example.org – 800-236- 7400 x 3252
Kent is a subject matter expert on 401(k), retirement accounts, investments, and financial services. Kent is also a published author.