Keep More of What You Earn by Adopting an Ideal Retirement Plan
As a small business owner, there are many plan design options available to help you achieve personal and corporate retirement planning goals. Plan designs range from straight-forward IRA-based arrangements like simplified employee pension (SEP) or savings incentive match plans for employees (SIMPLE) plans, all the way to ultra-sophisticated 401(k), defined benefit and profit sharing plans. The type of plan design you choose will be driven by your business’s cash flow, employee demographics and your own objectives.
Not sure where to start? Use of the “Plan Suitability Survey” (insert link) can facilitate this process. This survey will help you identify your business and personal objectives, and help determine the type of plan design best suited for your situation. Of course there’s a little more to it than that, like engaging with the appropriate planning professional to guide you through this process. Designing the ideal plan for your business will help you maximize contributions and deductions for yourself and business, while providing a valuable and thoughtful benefit to your employees. So let’s get started!
When determining the ideal plan design you must first understand some of the basics regarding what types of plans are available, who can sponsor various types of plans and who will be allowed to contribute (i.e., you as the business owner, the employee or both). The following comparison of the most common plans offered by small businesses may be useful as you begin this decision.
| IRA-based plans | Qualified plans | |||||
| SEP | SIMPLE IRA | 401(k) with profit sharing |
401(k) with salary deferral only | Defined benefit | ||
| Who can establish | Any business | Any business with 100 or fewer employees that does not maintain another plan |
Any business (Note: 401(k) feature not allowed for governmental entity) | Any business, except a governmental entity |
Any business | |
| Who contributes | Employer | Combination of employer and employee | Combination employer and employee | Employee | Generally funded by employer | |
| Maximum employer deduction* | 25% of eligible payroll | Based on required employer contribution for the year |
25% of eligible payroll | 25% of eligible payroll | Deductible amount based on funding level of plan; can be greater than 25% of eligible payroll | |
| Maximum potential per participant contribution (assuming age 50 or older) | $57,000 for 2020
$58,000 for 2021 |
Deferrals of $16,500 for 2020 and 2021; combined employee and employer contributions of up to $33,000 for 2020 and 2021 | Deferrals of $26,000 for 2020 and 2021; combined employee and employer contributions of up to $63,500 for 2020 or $64,500 for 2021 | Deferrals of $26,000 for 2020 and 2021 | Participant benefit accruals can be greater than $57,000 for 2020 or $58,000 for 2021 depending on benefit formula | |
The best way to begin a discussion about the ideal retirement plan is to start with this question: How much can my business afford to contribute? Other important questions include
- Do I want the contributions to be mandatory (fixed) or discretionary (flexible)?
- What are the cost considerations?
The following table offers plan type and feature options based on how much you as the business owner can afford to contribute. (Threshold amounts are based on calculations that use the IRS contribution rules.)
Combining plan types may be ideal in helping you achieve your company and individual retirement savings goals. For example, combining plan types such as a 401(k) with a cash balance plan is one way to maximize retirement plan contributions. In addition, you have additional flexibility using more complex allocation formulas and strategies that often allow you, the business owner, and other select participants to receive a greater share of the overall contribution as compared with other participants. As a result, business owners can often receive the maximum contribution amount allowed by law while rank and file employees receive lesser amounts.
There is not a one size fits all solution for establishing a retirement plan. It is critical that you first identify what is important to you as a business owner, whether your retirement plan offering will involve company contributions and, if so, how much you can afford to contribute. It is also important to remember that you may be able to change or enhance the plan you initially establish as your business grows. So make sure that you are leveraging tax and financial professionals to help you evaluate your options and find a solution that will help you and your business achieve your retirement savings goals and provide a sound saving option for your employees.
This material is for informational and educational purposes only and is not intended to provide, and should not be construed as, or relied upon for, tax, legal, investment or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction, including, for example, establishing a retirement plan for your company or retaining a service provider for your company’s retirement plan.
