You know we’re big fans of helping Americans put some money away for retirement. In helping so many businesses start their first 401(k) plan, you might think a 401(k) is the right call for all small businesses when they are ready to add a retirement plan.
Well, maybe. You may not know, but there are quite a few different retirement options out there designed for small businesses. Let's go over the essentials so you too can make the right decision for your company.
Three options stand-out depending on how much flexibility you need and what you want to accomplish with your plan. These are: 401(k) plans, SEP IRAs and SIMPLE IRAs.
So answer these questions and we can start honing in on the best fit for your business:
- Do I want to allow employees to contribute to the plan?
- If so, will some want to save more than $15,500 a year?
- Do I need flexibility to access the funds prior to retirement for emergencies?
- How important are managing future taxes (a Roth option) versus my tax needs today?
- Can I afford a match for my employees?
Other things to consider include whether you want a profit-sharing option or not, and do you have a business that experiences high employee turnover. If you expect high turnover, a 1-year eligibility requirement, vesting schedule for profit sharing, and/or matching contributions can be a great way to go.
Now that you’ve answered those questions, here’s the scoop to help you identify the right retirement benefit for your company.
The 401(k) Offers the Most Flexibility and High Contribution Limits
The 401(k) plan is probably the most widely known retirement product on the market. It’s the fully loaded, high performance jet plane of retirement plans. It’s generally defined as one that enables a business owner and employees to make consistent, tax-deferred contributions during the length of their careers.
But 401(k) plans offer a lot more versatility than that. 401(k)s not only offer higher contribution limits than most other plan options, but also offer more choices in design to manage business costs and program saving goals. You can choose to match or not, provide a vesting schedule, or enable penalty-free access to funds via a loan if an emergency arises. 401(k) plans also allow for “catch-up” contributions after reaching the age of 50. In 2023, employees can contribute up to $22,500 if under 50 years of age, $30,000 if 50 or over.
For small businesses and employees that may fear higher tax rates in retirement, the Roth 401(k) enables participants to have their contributions taxed up-front, but withdrawals in retirement are tax-free, earnings and all. This can be a big help in managing your tax situation and money over time.
SEP IRAs are Pretty Easy to Start and 100% Funded by the Employer
Simplified Employee Pensions, more commonly referred to as SEPs, are also a popular retirement plan choice as they offer a contribution limit that’s similar to a 401(k). It doesn’t have all the bells and whistles of a 401(k) plan, but it’s a solid airplane that can get you to your destination. One of the most important things to understand about SEPs is that 100 percent of the contributions made are by the employer (no employee contributions allowed) and these dollars are immediately vested for the employee.
As of 2023, Roth contributions are now allowed in a SEP; however, no loan option, no profit-sharing option, and no catch-up contributions for those over 50 years of age like there are with a 401(k). But it also doesn’t generally have the added IRS tests and reporting that 401(k) plans do.
The SIMPLE IRA is a Solid, Affordable Third Option
I’m going to change my airplane analogy on this one. I compare a SIMPLE IRA to having the middle seat on the airplane. It’s just not as good as having the window or aisle seat and definitely not as nice as flying first class.
The SIMPLE IRA’s name is a bit misleading (it actually stands for Savings Incentive Match Plan for Employees -- not so simple some joke). While both employer and employee can contribute to the SIMPLE, the employer must match and matching is vested immediately. Also, the employee contribution limit is set at $15,500 for 2023, a full $7,000 less than a 401(k). The catch-up for those over 50 is also less at $3,500 versus $7,500 for a 401(k). It also doesn’t have loan options, but like the SEP, avoids IRS tests and reporting requirements of a 401(k). Note that a 401(k) plan with a Safe Harbor design automatically satisfies IRS tests if prefer a 401(k).
A summary of the top differences outlined here below:
Top Retirement Plan Options Summary
| 2023 | 401(k) | SIMPLE IRA | SEP IRA |
|---|---|---|---|
| Who can contribute | Employee; Employer optional | Employee & Employer | Employer only; must contribute for all eligible employees |
| Max Employee Contribution | $22,500 w/$7,500 catch-up if over 50 years old | $15,500 w/$3,500 catch-up if over 50 years old | Not applicable |
| Employer Contributions | Optional, up to 100% of an employee's compensation with a $66K cap via match, profit share, or other employer contribution | Required match of 100% on the first 3% of participating employee contributions or 2% of all eligible employee salaries | Optional, but only way to fund; up to 25% of an employee's pay with a $66K cap |
| Vesting Timing for Employer Contributions | Up to Employer - Immediate or Vest over time | Immediate | Immediate |
| Access to Funds before age 59 ½ | Penalty-free loans or 10% penalty for early withdrawal | 25% penalty for withdrawing within first 2 years of participating; 10% thereafter | 10% penalty for withdrawal before age 59 ½ |
Now you have the intel on what are considered the best retirement plan options for businesses with less than 50 employees. Wishing you well on your journey to a well funded retirement.
FYI, there is a SIMPLE 401(k) product too, but it’s very similar to SIMPLE IRA, so we focused on the SIMPLE IRA for comparison to the SEP and 401(k) in this story. This blog was updated in 2023 for contribution and other applicable feature changes.