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How to Choose the Right Retirement Plan for Your Small Business

Find out how to choose the right retirement plan for your small business. Read our extensive guide and get ready to make the right decision.

How to Choose the Right Retirement Plan for Your Small Business

Published on

Apr 24, 2023

Written by

Penelope Team

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Employees also benefit from the plans, as they receive additional savings through employer contribution matching, tax advantages on contributions, and potentially higher returns on investments than they would receive in a traditional savings account. Moreover, retirement plans can increase loyalty among workers and help small businesses retain their best employees.

Benefits of Offering a Retirement Plan to Employees

  1. Tax Benefits - Small businesses can take advantage of special tax credits and deductions when setting up retirement plans, which can result in significant savings. In addition, employee contributions are excluded from taxable income, resulting in further tax savings. 
  2. Employee Retention - By offering good retirement benefits, small businesses can incentivize employees to stay with the company longer, reducing costly turnover rates. This, in turn, helps small businesses save money on recruitment costs, and experienced staff members are more efficient and productive. 
  3. Enhanced Recruiting - Having a retirement plan in place can help small businesses attract qualified workers who otherwise may have chosen to work for larger companies. This is due to the fact that small businesses are viewed as being more employee-friendly and committed to their workforce when providing additional benefits such as retirement plans. 
  4. Affordable Solutions - Business owners have several options when deciding on a retirement plan, including 401(k)s and Simple IRAs that are both affordable and offer tax incentives. You can also choose from different investment vehicles such as mutual funds or stocks to diversify their retirement portfolio. 
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Types of Retirement Plans

When considering offering retirement plans for small businesses, there are several options available and weighing the pros and cons of each is important.

Although small business retirement plans can be beneficial in terms of tax savings, employee retention, enhanced recruiting, and affordability, small business owners should educate themselves on their rights and responsibilities before making a decision. 

Overview of Retirement Options for Small Businesses

401(k)s are among the most popular small business retirement plans. With a 401(k), small business owners can offer employees the chance to contribute a portion of their salary pre-tax, with employers able to match up to a certain percentage. SEP IRAs are similar in that they allow small businesses to make contributions on behalf of their employees, although the contributions are not tax deductible for employers. SIMPLE IRAs also enable small businesses to make contributions on behalf of employees but have more limited contribution amounts and restrictions than both 401(k)s and SEP IRAs. Finally, Profit Sharing allows small business owners to put aside money for retirement plans but does not require them to contribute an equal amount for each employee. We’ll dive into each type in more detail on the pros and cons of each below.

401(k) Plans for Small Businesses

Traditional 401(k) Plans

A 401(k) plan is a type of small business retirement plan that allows employees to make pre-tax contributions to their retirement accounts. In addition, employers may match employee contributions up to certain limits, providing an additional incentive for employees to participate in the plan. Employees can also opt for different investment options within the plan, allowing them to customize their retirement portfolios. 

Additionally, employers may be eligible for tax deductions on contributions they make to employee accounts, providing potential cost savings. However, there are some disadvantages associated with traditional 401(k) plans, including administrative fees and complex regulations that must be followed for the employer to remain compliant.

Safe Harbor 401(k) Plans

Safe harbor 401(k)s are a type of retirement plan that small businesses can provide to their employees. Unlike traditional 401(k)s, safe harbor 401(k)s have less stringent rules regarding employer contributions and vesting schedules. This allows small business owners to offer more generous retirement benefits without meeting as many requirements. 

One of the main advantages of a safe harbor 401(k) is that it reduces the employer's contribution costs by lowering the amount required for annual matching rates and allowing them to receive higher tax credits. Additionally, employers don't need to worry about complicated rules related to vesting schedules or coverage testing, so they can make contributions easier and faster. 

However, there are also some disadvantages small business owners should be aware of when considering a safe harbor 401(k). For example, employers must make contributions to all eligible employees annually. Additionally, employer contributions cannot exceed a specific limit each year, and there may also be restrictions on how much money can be invested in certain types of investments. 

Overall, safe harbor 401(k)s offer small businesses an attractive option for providing retirement benefits without having to meet as many requirements as traditional 401(k)s. When deciding on a 401(k) plan, small business owners should consider their options carefully before deciding which type of plan is right for them and their employees.

IRAs (Individual Retirement Accounts)

Difference Between an IRA and a 401(k)

One primary difference between an IRA and a 401(k) is that with an IRA (Individual Retirement Account), small business owners can only contribute up to $6,500 per year (or $7,500 if they're aged 50+). On the other hand, employers and employees can both contribute up to $22,500 into a 401(k) plan each year ($30,000 if they’re age 50 or older). Additionally, small business owners can set up a 401(k) plan for their employees to participate in, whereas an individual IRA is only available to the account owner.

Another key difference between IRAs and 401(k)s is that small business owners may be eligible for additional tax savings with a 401(k). With some small business retirement plans, employers may qualify for tax deductions when they contribute money into employee accounts. 

SEP IRAs

A SEP IRA (Simplified Employee Pension IRA) is another type of small business retirement plan that allows employers to make tax-deductible contributions to employees' retirement accounts regularly. It also enables small business owners to contribute significantly higher amounts than traditional 401(k) plans allow, making it an attractive option for small business owners who want to maximize their retirement savings. The setup process can be simpler than with 401(k)s and there are fewer administrative and compliance requirements.

The main advantage of using a SEP IRA is that employers can choose how much they want to contribute each year, making it easy to tailor benefits according to budget and company size. This also means small business owners don't have to make contributions every year, which can be helpful if resources are limited. Additionally, since employer contributions are tax deductible and not subject to payroll taxes, small business owners may be eligible for additional tax savings. 

However, with SEP IRAs, there is less flexibility in terms of employee contributions and employer matching, so small business owners should consider these factors when deciding which plan to choose.

SIMPLE IRAs 

A SIMPLE IRA (Savings Incentive Match Plan for Employees IRA) is a small business retirement plan that allows employers to make tax-deductible contributions to employees' retirement accounts on a regular basis while also providing employees an opportunity to contribute pre-tax money as well. Employers are able to make matching contributions up to certain limits and there is an incentive for employees to participate in the plan through employer match contributions. Furthermore, small business owners can easily set up a SIMPLE IRA with minimal administrative costs and compliance requirements. However, contribution limits are lower than other small business retirement plans, so small business owners should consider this when choosing which plan is best for their needs.

Difference Between a SEP IRA and a SIMPLE IRA

The main difference between the two plans is that employers determine how much they would like to contribute each year with a SEP IRA, making it easier to tailor benefits according to budget and company size. On the other hand, with a SIMPLE IRA, employers must match employee contributions up to 3% of the employee's salary each year, and make additional contributions regardless of whether or not employees choose to add funds themselves.

Additionally, small business owners can choose between pre-tax and Roth contributions with SEP IRAs, offering small businesses more flexibility in terms of retirement plan design. 

Choosing the Best Retirement Plan for Your Business

By offering a small business retirement plan, business owners can provide valuable benefits such as tax savings and additional incentives for employees to remain with the company while helping themselves prepare for their own retirement. With a variety of retirement plans available, small businesses can choose a retirement plan that meets their needs and the needs of their team. 

If you have questions about setting up a retirement plan, schedule a quick call with a retirement specialist today. We’ll walk you through your options and help you find the best plan for you and your employees.

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