401(k), SIMPLE IRA, SEP IRA
A Guide to 3 Retirement Savings Plans for the Small Business Owner
If you are self-employed or own a small business, then you may be wondering what retirement savings options are available to you. In the following guide, we provide a comparison of three advantageous retirement plans for self-employed individuals and small business owners: solo 401(k), SIMPLE IRA, and SEP IRA. Keep reading to learn more about the features of each plan, as well as the pros and cons of each.
Solo 401(k) Plan
A solo 401(k) plan, also known as a one-participant 401(k) or a solo K, is a great retirement savings option if you own your own business without having employees beside your spouse.
Let’s take a look at some of the key features of a solo 401(k):
- You can set up your solo 401(k) to operate as a traditional or Roth plan.
- There are no age or income restrictions for the plan.
- You must not have any employees for your small business other than your spouse in order to participate.
- You can contribute all of your salary to the plan up to the annual maximum contribution limit.
- You can save up to $22,500 annually (for 2023) as elective deferrals.
- You can take employer matching contributions with the plan; your business can contribute up to 25% of its profits to your solo K up to $66,000 annually (for 2023).
- The IRS considers both employee and employer contributions for annual contribution limits to the solo K plan.
- If you are age 50 or older, you may contribute $7,500 as a catch-up contribution (for 2023), in line with catch-up contribution limits of other 401(k) plans. The total annual contribution limit for those age 50 or older is $73,500 (for 2023).
- Your total employee contributions to all 401(k) plans, including your solo K, must not exceed the annual maximum contribution, which is $22,500 (for 2023).
- Even if you have maxed out your employee contributions to your 401(k) plans, you can still make an employer contribution to your solo K, exceeding the smaller, employee-only contribution amount.
Here are a few pros of the solo 401(k) plan:
- Employees can contribute all of their salaries, not just the 25% limit of other plans like the SEP and SIMPLE plans, allowing high-earners to save more.
- You can contribute to other 401(k) plans, as well as an IRA, in addition to your solo 401(k).
- You can set up your solo K at the financial institution of your choice.
- You’ll find the contribution limits are higher and more flexible than those of a traditional 401(k).
Here are several cons to the solo 401(k) plan:
- As with other 401(k) plans, you will be hit with taxes and penalties from the IRS if you withdraw funds before age 59½.
- You will be required to fill out a fair amount of paperwork to open a solo K. (It’s not something you can open online within fifteen minutes.)
- Once you exceed $250,000 in assets at the end of the year, you will be required to file a special form with the IRS annually.
Now let’s take a look at the SIMPLE IRA.
SIMPLE stands for Savings Incentive Match Plan for Employees, and it’s a viable retirement savings option for employers and the self-employed with no more than 100 employees earning $5,000 the previous year.
SIMPLE IRAs give employers a simplified way to offer a retirement savings plan to their employees without the administrative hassle of a traditional 401(k) plan.
Here are some key features of the SIMPLE IRA:
- You can set up your SIMPLE IRA to operate as a traditional or Roth plan. With the former option, contributions are made tax-deferred. With the later option, after-tax contributions grow tax-free, and qualified withdrawals in retirement are tax-free.
- You can contribute up to $15,500 (for 2023), and if you are age 50 or older, you can make a catch-up contribution of up to $3,500 (for 2023).
- Employers must contribute to their employees’ SIMPLE IRA plans by either 1) matching employee contributions dollar-for-dollar up to 3%; or 2) contributing 2% of employee wages up to the annual limit of $330,000 (for 2023).
- If you withdraw funds from a traditional SIMPLE IRA before age 59½, you may be subject to a 10% bonus penalty, plus a 25% levy in special circumstances.
- If you withdraw funds from a Roth SIMPLE IRA before age 59½, you won’t be taxed on contributions withdrawn, but you will be taxed on earnings.
- The Roth SIMPLE IRA was created in 2023 as a part of the SECURE Act 2.0.
- You can set up automatic paycheck deductions with a SIMPLE IRA, as you would with typical 401(k) plans.
- You must begin taking required minimum distributions from your SIMPLE IRA by age 73.
- You can set up a SIMPLE IRA if you are the owner of a business employing no more than 100 people, including sole proprietorships.
- SIMPLE IRAs offer immediate vesting of employer contributions for employees; the money is legally theirs as soon as it is deposited into the account.
Here are a few pros to consider for the SIMPLE IRA:
- Save money tax-deferred or tax-free. With a SIMPLE IRA, you get to choose whether you want to make tax-deferred contributions or after-tax contributions that grow tax-free and aren’t taxed upon withdrawal in retirement, just like a traditional or Roth 401(k).
- Make larger contributions than with either traditional or Roth IRAs, as well as traditional 401(k)s.
- Employees enjoy immediate vesting on any employer matches.
Here are several cons to the SIMPLE IRA:
- SIMPLE IRAs are only available to small employers with 100 or fewer employees.
- Employers are required to fund their employees’ SIMPLE IRA accounts every year.
- SIMPLE IRAs are subject to taxes and penalties for early withdrawal, just as with traditional 401(k)s and other 401(k) plans.
Finally, let’s take a look at SEP IRAs.
SEP stands for Simplified Employee Pension, and this retirement savings plan is yet another great option for employers, including those who are self-employed.
Here are the key features of an SEP IRA:
- You can choose whether you will contribute tax-deferred money or allow your after-tax money to grow tax-free and withdraw the funds tax-free in retirement.
- SEP IRAs are easy to set up and require minimal paperwork from the IRS.
- Employees are granted immediate 100% vesting into all contributions. Make larger contributions than what you could contribute to either a traditional or Roth IRA, or a 401(k) plan.
- Enjoy flexibility, as you do not have to contribute to an SEP IRA every year, either for yourself or for your employees.
Here are a few cons of the SEP IRA:
- The SEP IRA requires employer contributions, even though employees cannot contribute to the plan. You must offer your employees the same percentage of employee compensation as you do for yourself.
- No catch-up contributions are available for SEP IRA participants who are 50 or older, as with other IRAs and 401(k)s.
- As with other traditional IRAs and 401(k)s, you will be subject to taxes and a 10% bonus penalty for early withdrawals before age 59½. With a Roth SEP IRA, you won’t be taxed or penalized for early withdrawals of contributions, but you will be for early withdrawals of earnings.
We hope this comprehensive guide gives you a clear picture of several retirement savings options for small business owners and their employees. Whether you choose a traditional or Roth solo 401(k), SIMPLE IRA, or SEP IRA, you can potentially put away a sizable nest egg for your retirement and help your employees do the same.
Have questions about retirement planning? The accounting experts at Honest Buck can help. Contact us today to discuss a retirement savings plan that works for you.
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