We frequently have discussions with small business clients to help them evaluate the most appropriate retirement plan for their business.  Considerations in selecting the best plan include the company cost, analysis of employee contributions relative to owner contributions, tax deferral benefits and administrative costs.

A Simplified Employee Pension (SEP) is the most common for self-employed individuals earning consulting income and who do not employ others.  A SEP allows for contributions that approximate 20% of self-employment income up to a maximum contribution of $69,000 in 2024. This plan is easy to establish with your investment advisor and does not require any tax filings or outside services to administer the plan.

A Defined Benefit Pension Plan is used most often for a business with no employees and an older owner (age 45+) with consistent high earnings.  The contributions to this type of plan are determined by an actuary, which for 2024 can be as much as $275,000.  The contribution is dependent on your age, earnings and prior funding to this plan. There are administrative costs and tax filings for this type of plan, but given the significant tax deferral opportunity it should be considered in the right situation.

Many start up small businesses adopt a SIMPLE IRA.  This plan is allowed for businesses with fewer than 100 employees that want to encourage employee contributions.  For 2024, employees are allowed to contribute up to $16,000 and an additional $3,500 for those employees over age 50.  The cost to the employer is a matching contribution for those employees participating equal to 3% of the employee’s compensation or a 2% contribution for all eligible employees’ compensation, regardless of whether they are making individual contributions to the plan.  This plan is easily established with your investment advisor and does not require any tax filings or outside services to administer the plan.

The most common retirement plan we encounter is a 401(k) profit-sharing plan.  Even if you do not own your own business, you are likely an employee that wants your employer to offer this benefit.  The 2024 contribution limit is $24,000 plus an additional catch-up contribution of $7,500 for employees who are 50 and older.  Many plans allow for employee contributions to be traditional (pre-tax dollars) or ROTH (post-tax dollars).  Individuals should consult their investment advisor as to the best option based on their age and income.

Typically, a 401(k) plan needs some employer contribution to pass the required compliance testing and allow for the higher earning owners to fully fund their 401(k) deferrals.  This is frequently done via a fully vested safe harbor contribution of 3% of all eligible employees’ earnings regardless of whether the employee chooses to defer contributions.  This option is considered when the employer desires to fund additional profit-sharing contributions.

Sometimes the employer will opt for a safe harbor match which requires the employer match 100% of the first 3% of employee 401(k) deferrals and at least 50% of the next 2% of deferrals up to a minimum of a 4% matching contribution.  This option can be less costly if the employer does not want to fund any additional profit-sharing and if most employees are not making their own 401(k) deferrals.

Many business owners establish a 401(k) plan in conjunction with a profit-sharing plan so that the total contributions including 401(k) deferrals can be up to $69,000 or $75,500 for individuals over age 50 in 2024.  This can be done as a fixed percentage profit-sharing contribution for all employees. Another option is an age weighted, new comparability or cross tested plan which typically allow for a larger percentage contribution for older and key employees and a smaller contribution for all the other employees.  The 401(k) and profit-sharing plans require the cost of a retirement plan administrator and an annual tax filing (Form 5500).

What retirement plan is right for your business? Is it time to reconsider the retirement plan benefit you provide for your organization?  Working together with your retirement plan administrator, we can help you evaluate the options.

 

By: Steven Braunstein