What type of retirement plan to use is a big question for employers. Not only do they want to do what’s right for the business, but they also want to do what’s best for their employees and future employees.
In the following article, we’ll break down three of the most popular options for employer-sponsored retirement plans.
What are your options?
If you’re an individual, your options are pretty straight forward. Outside of your employer-based plan, you can either contribute to a Roth IRA or a Traditional IRA.
As a business, however, you have many other options. For organizations that are for-profit and not a government body, you the SEP IRA, SIMPLE IRA, and the 401(k).
More than likely, you’re most familiar with the 401(k). We’ll explore each of these below.
Stands for Simplified Employee Pension Individual Retirement Account.
This retirement account is typically used with one-man shops or small businesses with a couple of employees.
The reason is the money contributed to the employee’s accounts can only come from the business. Employees are not eligible to contribute to their SEP account.
Here the characteristics of a SEP IRA:
- Must contribute the same percentage of salary for each employee
- Don’t need to contribute every year
- Maximum contribution is $54,000 per year or 25% of annual salary, whichever is less
- Contributions are deductible as a business expense for the entity
- Money grows tax-deferred
- When funds are withdrawn, they are taxed as ordinary income
- Rules similar to a Traditional IRA
- Withdrawals prior to 59 ½ unless used for a qualified purpose (qualified meaning exempt from the penalty, which is 10%)
- Required Minimum Distributions must begin at 70 ½
Stands for Savings Incentive Match for Employee Individual Retirement Account.
Designed for small businesses, and has an employee limit of 100. If you go over 100 employees, you need to switch to a 401(k).
The SEP and SIMPLE (compared to the 401(k)) are inexpensive to set up and administer, and may be a great option for small businesses that want to offer a plan for their employees, but don’t want to pay the costs associated with a 401(k).
Here are the characteristics of a SIMPLE IRA:
- Contribution limit of $13,000. A catch-up contribution of $3,000 for those 50 or older
- Employees can contribute to their own plan (unlike the SEP)
- Employers match contributions
- Match up to 3% of employee’s contribution (doesn’t have to contribute if the employee doesn’t contribute).
- Contribute a flat 2% whether or not the employee contributes.
- Similar to the last plan, withdrawals before 59 ½ are penalized.
- Also similar to the last plan, distributions must begin at 70 ½
- There’s a weird quirk with the Simple, as well. If you withdraw funds earlier than 2 years after your first contribution, you’re penalized 25%.
The 401(k). The plan that most people are familiar with, and if you have an employer-sponsored plan, it’s more than likely, this one.
The 401(k) gained popularity as companies switched from defined benefit plans (pensions) to defined contribution, where it became the responsibility of the employee to save for retirement instead of the employer.
Here are the characteristics of the 401(k):
- Contribution limit is $19,000 with a catch-up of $6,000 for people 50 or older.
- Total contribution limit, including employer contributions, is $54,000.
- The 401(k) is an expensive plan to set up and administer, especially when compared to the previous two plans.
- Like the previous two plans, the 401(k) penalizes you if you withdraw before 59 ½ unless your reason for withdrawal qualifies for an exemption. And you must begin withdrawing funds when you turn 70 ½.
- With this plan, however, you are able to take a loan out against your savings. This loan has to be paid back, usually in the form of increased monthly contributions.
- If you are let go from your job while you have a loan on the plan, you will be forced to pay it back with 60 days. If you don’t you’ll be taxed on the amount, and if you’re under 59 ½, you’ll be penalized 10%.
- This type of plan is designed for larger employers, though there is no maximum or minimum on how many employees you can have.
- They have a type of 401(k) called the solo 401(k). It has all the same rules and quirks as the standard 401(k), but it’s designed for someone who works by themselves OR their only employee is a spouse.
How to choose
Unfortunately, I can’t say which plan is the best. Each one has its own unique advantages and disadvantages.
When deciding which plan is best for you and your business, there are a few things I would take into consideration.
- Number of employees – some plans disqualify you if you have too many employees.
- Matching ability – Most 401(k) plans match up to 6%. The SIMPLE requires you to match up to 3% or contribute a flat 2% for every employee.
- Cost – Some plans are less expensive to set up and service than others. In terms of the 401(k), the more participants and assets you have in the plan, the less expensive (per user) it becomes.
- Attracting talent – More and more employers are using benefits packages to attract employees rather than salary, in what’s called all-in compensation. If you want to get qualified candidates in the door, you have to offer good benefits.
It should be known that whatever you decide, it’s not set in stone. If you set up a SIMPLE and you need to hire more employees than you anticipated, you can set up a 401(k). The SIMPLE will have to stay in place, and you’d just have current and new employees contribute to the 401(k).
For more information on all of these plans and others, read this article here.
Be advised: The numbers and figures listed in this article are for 2019. Contribution limits tend to change over time. Please review the IRS website for up to date information.
My name is Jacob Sensiba and I am a Financial Advisor. My areas of expertise include, but are not limited to, retirement planning, budgets, and wealth management. Please feel free to contact me at: firstname.lastname@example.org