Presented by Melissa Gerhardt
As a small business owner, you’ve reached a certain level of success and built a comfortable future for your family. Depending on the size of your company, you’ve also created jobs, so your employees can provide for their families. But what’s the next step? Establishing a retirement plan for your small business will help ensure that you and your employees have a steady stream of income—even after you retire.
There are many types of retirement plans available to companies, but a select few are most beneficial to small business owners. SEP IRAs, SIMPLE IRAs, and safe harbor 401(k)s are the most commonly used plan types because of their simplicity, affordability, and minimal administrative requirements.
| SEP IRA | SIMPLE IRA | SAFE HARBOR 401(K) | |
| Suitable for | Corporations, sole proprietors, partnerships, and nonprofit entities | Corporations, sole proprietors, partnerships, and nonprofit and government entities with 100 or fewer eligible employees | Corporations, sole proprietors, partnerships, and nonprofit entities |
| Who Contributes | Employers only | Employers and employees | Employers and employees |
| Contribution limits | • For 2024: The lesser of 25% of compensation or $69,000 • For 2023: The lesser of 25% of compensation or $66,000 • For Schedule C: Limit is 20% instead of 25% | Employees: • For 2024: $16,000 • For 2023: $15,500 Employers with 25 employees or less, deferral and catch-up contribution limit increases by an additional 10% to $17,600 ($21,450 over age 50). Employers with 26 or more employees must increase the matching or nonelective contribution rate by 1% in order for the deferral and catch-up contribution to increase by 10% Employers: Mandatory match of up to 3% of compensation for participating employees or mandatory nonelective contribution of 2% for all eligible employees. Optional additional nonelective contributions can be made not to exceed the lesser of 10% of compensation or $5,000. | Employees: • For 2024: $23,000 • For 2023: $22,500 Employers: • Mandatory nonelective contribution of 3% or 100% match of employee deferrals up to 3% of compensation, plus 50% match of employee deferrals in excess of 3% and up to 5% of compensation (for a total of 4%) |
| Catch-up contributions for age 50 and older | None | • For 2024: An additional $3,500 (increased by 10% to $3,850 if above conditions are met) • For 2023: An additional $3,500 | • For 2024: An additional $7,500 • For 2023: An additional $7,500 |
| Annual IRS tax filing | None | None | Form 5500 |
| Deadline to establish | Employer’s tax-filing deadline, including extensions (if filed for) | • Plan must be established by October 1 for contributions in the same year | • Plan must be established by October 1 to be eligible for the current year |
| Deadline to Contribute | Employer’s tax-filing deadline, including extensions (if filed for) | • Employer contributions are due by the employer’s tax-filing deadline, including extensions (if filed for) • Employee salary deferrals should be deposited as soon as administratively possible but no later than 7 calendar days following the last day of the month for which deferrals are withheld | • Employer contributions can be made up to the employer’s tax-filing deadline, including extensions (if filed for) • Employee salary deferrals must be made as soon as administratively possible but no later than the 15th of the month following the month in which they were deferred |
Overview of Each Plan Type
SEP IRA
Benefits
- This plan is easy to set up and administer.
- Annual compliance testing and IRS filings are not required.
- Contributions are tax deductible.
- Employer contributions can vary each year, and they do not have to be made every year.
- Example: An employer can contribute 4 percent one year, 0 percent the next year, and
- 2 percent the year after that.
- Employers can exclude certain employees, such as anyone younger than 21, those who have not been employed for at least three of the past five years, or those who have earned less than $750in either the current or prior year.
Important Considerations
- This plan is employer funded. No employee salary deferrals are allowed.
- The same contribution percentage must be used for all eligible employees, including you as the employer.
- Loans are not allowed.
- There is no catch-up provision for those age 50 and older.
SIMPLE IRA
Benefits
- This plan is easy to set up and administer.
- Annual compliance testing and IRS filings aren’t required.
- Employer contributions are tax deductible.
- Employee salary deferrals are allowed and there is a catch-up provision for those age 50 and older.
- Employers can exclude employees who have not received at least $5,000 in compensation during any two preceding calendar years (do not have to be consecutive years) and who are not expected to earn at least $5,000 in the current year. So, if you decide to hire employees in the future, you may be able to keep this plan type in place until they become eligible without having to contribute a match.
Important Considerations
- Employer contributions are mandatory. Employers must make either a nonelective 2 percent contribution to all eligible employees regardless of participation or match 100 percent of employee deferrals up to 3 percent of compensation.
- SIMPLE IRAs have a unique two-year rule associated with their distributions and rollovers. They cannot be rolled over to any other retirement account (except another SIMPLE IRA) within the two-year period beginning on the first date of participation in the plan. In addition, IRA owners younger than 59½ who distribute within the two-year time frame (without a premature distribution exception) will be fined a 25 percent premature penalty instead of the normal 10 percent penalty.
- Loans are not allowed.
- New for 2024 – Employers can switch from a SIMPLE IRA plan to a Safe Harbor 401(k) during the plan year.
- Tax credits offset startup costs: Employers with up to 50 employees can receive a tax credit to offset startup expenses. The amount of the credit is equal to the lesser of 100 percent of eligible startup costs (i.e., ordinary and necessary expenses paid by the employer to set up and administer a new qualifying retirement plan and educate employees about the plan) or $5,000 annually in the first three plan years.
- Employer contribution tax credit: For eligible employers, this credit is equal to the applicable percentage of the contribution amount, up to $1,000 per employee (for employees earning less than $100,000 annually), in each of the plan’s first five years. It applies to plans adopted after December 31, 2022.
Safe Harbor 401(k)
Benefits
- This plan has the same features as a traditional 401(k) without the annual nondiscrimination testing.
- Employer contributions are tax deductible.
- Employees are allowed to contribute.
- Profit-sharing contributions from the employer are allowed.
- Loans are allowed.
Important Considerations
- Employer contributions are mandatory. For a 401(k) to be a safe harbor plan, employers must do one of the following:
– Make a nonelective 3 percent contribution to all employees regardless of participation.
– Match 100 percent of employee deferrals up to 3 percent of compensation, plus 50 percent of employee deferrals in excess of 3 percent and up to 5 percent of compensation (for a total of 4 percent).
- Although nondiscrimination testing is not required, Form 5500 must still be filed annually.
- Distributions from this plan require a triggering event.
- SECURE 2.0 requires certain plans starting after December 29, 2022, to use automatic enrollment. While the requirement is not effective until 2025, you may consider including automatic enrollment at the time of launch to benefit from the following tax credit sooner.
Which Plan Should You Choose?
With so many choices available, it can be difficult to find the right fit. You might start by asking, “What’s most important to me in a retirement plan?” Here are a few examples:
- If low cost and minimal maintenance are priorities for your business, a SEP or SIMPLE IRA would be an appropriate fit.
- If you have highly compensated employees and want to give them the opportunity to maximize their retirement savings, a safe harbor 401(k) would allow for that, as long as you are willing to make the employer match.
- If you are a sole proprietor with no employees and want to maximize your own retirement savings, a SEP IRA could be your best option.
By understanding what each plan has to offer (and what it doesn’t), you’ll be well prepared to make the best choice for your retirement, as well as the retirement of your employees.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
© 2022 Commonwealth Financial Network
