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Kyle Johnston

Retirement Plan Options for Small Business Owners and Self-Employed Individuals

Looking for retirement plan options to suite your small business needs? In this piece we detail the different plans and which types of businesses may benefit from each.



Contents:

  • Overview and associated contribution limits/requirements of:

    • SEP IRA

    • Individual 401(k)

    • SIMPLE IRA

  • Comparison of the three account types

  • Examples of which types of businesses each plan may be best suited for


As a small business owner or self-employed individual, it can be easy to forget about planning for retirement as you tackle the day-to-day challenges of running your business. Leveraging a traditional or Roth IRA can be a good start, but these accounts carry much lower contribution limits than small business retirement plans offer. 401(k) plans can be costly for a small business to run and administratively burdensome to maintain. Below, we outline the alternative choices across small business retirement plans including SEP IRAs, SIMPLE IRAs and individual 401(k)s.


SEP IRA (Simplified Employee Pension IRA)

SEPs enable self-employed individuals or small business owners to contribute a much higher amount to a tax-deferred retirement account than a traditional or Roth IRA offers. For 2024, the maximum contribution for Traditional IRA and Roth IRAs is $7,000, while the maximum for a SEP IRA is the lesser of 25% of total compensation (20% of self-employment net income) or $69,000. One important aspect of SEP plans is that, if you have employees, the percentage of income that you contribute to your own IRA must also be contributed to your employees’ accounts. So, if you contribute 10% of your own compensation to your account, you must also contribute 10% of each plan eligible employees’ compensation to their SEP accounts. SEPs do not allow for employees to make salary deferral contributions, though employees may be able to make traditional IRA contributions up to the annual limit, so all SEP contributions come from the employer. Due to the rules related to contributions and the requirements for contributions to employees who are eligible for plan participation, SEPs are often best suited for those who are self-employed or those who earn freelance income.


Individual 401(k)

Individual 401(k)s are another plan type available to self-employed individuals, sole-proprietors, and independent contractors with no employees. These plans can enable even higher contributions than a SEP IRA plan, as you can make contributions as both the employer and the employee. Employer contributions can amount to 25% of compensation, not exceeding $69,000 for 2024, while employee contributions can be up to 100% of compensation with a maximum of $23,000. Spouses may also be able to participate in the plan if they also take taxable income from the sole-proprietorship. For those truly looking to maximize the contributions made from self-employment income, these plans can be a good fit. Employee contributions can be made on an after-tax (Roth) basis.


SIMPLE IRA (Savings Incentive Match Plan for Employees)

For business owners who are wishing to offer their employees the option to make salary deferrals, the SIMPLE IRA can be a good place to start. These plans are available to any business with 100 or fewer employees. While the contribution limits are not quite as high as SEP IRA or 401(k) plans, they are still much higher than Traditional or Roth IRA limits. For 2024, employees can contribute up to $16,000 while employers can contribute up to 3% of an employee’s compensation on a dollar-for-dollar match basis. This matching contribution can be reduced to as low as 1% in any two years in a five-year period. Employers can also make a non-elective contribution of 2% of each employee’s compensation rather than making the dollar-for-dollar match. If an employee elects not to participate, the employer does not need to make any contributions on their behalf. Relative to a 401(k) plan, SIMPLE IRA plans can offer the ability for employees to make salary deferral contributions, receive an employer match on their contributions, and contribute more than the annual Traditional IRA limit. SIMPLE IRA plans are also less costly and less burdensome from an administrative standpoint than a 401(k) plan, making them a good option for small businesses who would like to begin offering retirement benefits to employees.


Comparing and Contrasting Plan Types


Employee Contribution Limit

Employer Contribution Limit

Employer Contribution Requirements

Roth Option?

SEP IRA

Annual Traditional IRA Limit ($7,000 for 2024)

Lesser of 25% of compensation (20% of self-employment income) or defined contribution plan basic limit ($69,000 for 2024)

Contribution must be made to each eligible employee participant at the same ratio to compensation

Enabled by the Secure Act 2.0 but not offered by all custodians

Individual 401(k)

Annual 401(k) contribution limit ($23,000 for 2024)

Lesser of 25% of compensation (20% of self-employment income) or defined contribution plan basic limit ($69,000 for 2024)

n/a, combination of employer and employee contributions cannot exceed defined contribution plan basic limit

Yes

SIMPLE IRA

Annual SIMPLE IRA Limit ($16,000 for 2024)

3% of employee compensation

3% dollar-for-dollar match on employee contributions (can be reduced to as low as 1% for any 2 years in a 5-year period) or 2% non-elective contribution based on employee’s compensation

No

Which Plan Fits Your Business Best?

Choosing the most suitable retirement plan is critical for small business owners to avoid surprises and maximize their ability to save for retirement in a tax efficient manner.

  • SEPs are often best suited for self-employed individuals with no employees, or for business owners that wish to contribute to employee retirement, but maybe not every year.

  • Individual 401(k)s can enable high earning self-employed individuals to put away much more for retirement than is possible in the other account types.

  • SIMPLE IRA plans can be an effective tool for small business owners to provide a salary deferral retirement plan option to employees. They also provide the benefit of employer matching contributions but without the cost and administrative burden of a 401(k) plan.


At the end of the day, small business owners and self-employed individuals who are looking to establish a retirement plan and maximize their contributions may benefit from consulting the advice of experienced tax professionals and/or financial advisors. Choosing the plan that is most suitable for your business can avoid headaches down the road. Over time, and as your ability to contribute to employee retirement changes, you can close one plan type and switch to another.


Want to discuss your options with one of our experienced advisors? Reach out to us at kjohnston@1620ia.com.

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