How to Choose the Right Retirement Plan for Your Small Business
Small business retirement plans offer an ideal way to incentivize worker loyalty, save for your own retirement, and reduce your tax burden for the year. The best way to choose the right retirement plan for your small business is to work with a low-fee 401(k) provider like Ubiquity, who can help you ask the right questions and customize a savings vehicle that meets all of your needs. Plans vary based on contribution amounts, who may contribute (employer or employee), and administration requirements. There are several critical factors to consider when selecting your company’s retirement plan.
Types of Small Business Retirement Plans
Since Social Security only replaces about 40% of one’s working income, most people will need a retirement savings account to help fund their desired lifestyle. Small business retirement planning options include:
- Defined contribution plans / 401(k)s: Defined contribution plans remain popular among small businesses because they offer high limits and are typically managed by a third-party administrator, which lowers risk for employers and increases flexibility and support for workers.
- Employers may contribute up to $61,000 to a 401(k) plan in 2022, plus $6,500 in catch up contributions for those age 50 and older. These plans may be vested, in which case employer contributions only become available after a set number of years. Employees cannot contribute to the plan.
- In 2022, a 401(k) allows employees to save up to $20,500, plus up to $6,500 in catch-up contributions for those age 50 and older. Employers can also make contributions to the plans to a total balance of $61,000 – $67,500. While plans must pass annual nondiscrimination tests, adding a Safe Harbor provision can help alleviate this requirement if the employer agrees to contribute at least 3% of employee salaries to the plan or chooses a matching formula.
- Individual retirement accounts (IRAs): IRAs are popular among small businesses due to the ease and cost-effectiveness of setup, though some IRAs have higher limits than others.
- The Payroll Deduction IRA is employee-funded and auto-transfers money from each paycheck into the fund. The maximum contribution in 2022 is $6,000 (+$1,000 for those age 50 and older).
- The Simplified Employee Pension (SEP) IRA allows employers to contribute a percentage of employee salaries into the account, though it must be the same for each employee. This amount can vary from year to year, depending on company profits. Employers can put up to 25% of employee compensation into the plan up to $61,000 in 2022; however, voluntary employee salary deferrals and catch-up contributions are not allowed.
- Lastly, the Savings Incentive Match Plan (SIMPLE) IRA allows employer and employee contributions up to $14,000 in 2022, with a $3,000 catch-up allowance for those age 50 and older. If employees contribute, the employer must dollar-for-dollar match on the first 3% of the employees’ salaries. If employees do not contribute, employers must put in 2% of the employees’ salaries up to the maximum limit.
- Defined benefit plans / pensions: Few employers (about 14%) offer the classic traditional pension plan these days. While you can still find open-ended arrangements in some unionized industries, they are uncommon among small businesses due to the expense.
- With a cash balance pension, employees can choose to take a lump sum or monthly payments at retirement. For 2022, workers could set aside up to $245,000 a year in a tax-deferred pension fund, though the plan will need to pass nondiscrimination testing that shows fair contributions to all employees. On top of this allowance, employees and employers may also contribute to 401(k)s.
Whichever type of retirement savings plan you choose, you and your employees will have the opportunity to reduce your taxable income for the year as you grow your money tax-deferred.
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Tax Advantages and Other Incentives of Small Business Retirement Plans
Why pay more taxes than you need to? In addition to saving for your future, small business 401(k)s let you reduce your tax burden this year. You’ll pay taxes on the money as it’s withdrawn in retirement, after years of accruing interest and growing your nest egg.
Consider these tax advantages of a 401k for small business owners:
- Employers and employees can deduct contribution amounts from taxable income for the year.
- Businesses enjoy a tax credit equal to 50% of new plan startup costs (up to $500) for three years.
And there are advantages for employees as well:
- Low and moderate-income employees can receive 10-50% (up to $2,000) as a “Saver’s Credit.”
- A Roth program can be added that lets employees make after-tax contributions and withdraw tax-free.
Small Business Retirement Planning Questions to Consider
When choosing the right plan for your business, ask yourself:
- Do I need high limits to allow key employees and owners the ability to contribute the maximum?
- Am I worried about employee turnover and wish to reward loyalty with a vesting schedule?
- Do I want to lower liability and increase investment choice flexibility?
- Do I want to offer matching funds to encourage plan participation?
- Am I comfortable contributing the same amount each year, or do I want it to vary based on profits?