Small business owners who wish to offer their employees the perks of a retirement plan have to make the decision on what type of plan to choose. This is a decision that must be made even if the retirement plan is simply for their own retirement and not for employees. Choosing a 401k plan or an IRA plan is a decision that must be made carefully so that all laws are followed that are in place by the IRA and so that the best financial decision is made that maximizes the funds. There are many factors that have to be considered when setting up a retirement plan. The following is an overview of what should be understood in order to make the best decision.
Small business retirement plans are one of the best ways to save for retirement and at the same time defer tax-deductible money. The EGTRRA or Economic Growth and Tax Relief Reconciliation Act of 2001 provides many incentives for small businesses to save money for their golden years of retirement. This act literally allows small businesses to choose between saving the profits they make for later use in life and sending them to the IRS in the form of taxes, not a difficult choice to make.
Small business owners typically make their decision on a retirement plan based on how the plan will benefit them. Employees will benefit from having a retirement plan but the bottom line is that the selection of which plan to choose will ultimately be based on how the owner of the company will benefit. The good news for employees and business owners is that the new tools put in place by the IRS and the government has made it possible for both employees and owners to win.
Understanding the different types of plans is the next step in the process of choosing one that will work for the business and the employees. There are several types of plans to choose from that will be explained below.
SEP (Simplified Employee Pension)
The Simplified Employee Pension plan or SEP is, as the name implies, the simplest retirement plan for a small business and self-employed people to set up. It is also the easiest of all the retirement options to maintain. An SEP can be set up by self-employed individuals who have no employees but pay taxes on earned money. The SEP is considered an Individual Retirement Account and if a small business chooses the SEP then it is a group of IRAs.
The SEP is a good choice for the small business because all of the contributions to the SEP are considered tax deductible. Additionally, the earnings of the plan are tax free until they are withdrawn from the account. If withdrawal occurs before retirement age, or 59, there is a penalty assessed on the money of 10%.
The SEP has both good and bad points that must be considered. One of the negative aspects of the SEP, for many people, is that these accounts do not allow loans to be taken from the account. These accounts also do not allow salary deferred contributions. There is also a limit on the amount of money that can be contributed in one year which may change annually and should be determined before the start of the plan.
The Individual 401k
The individual 401k is another by-product of the 2001 EGTRRA tax measure. This is an ideal option for the small business owner who has no employees or whose spouse is the only other employee. This type of retirement plan has higher contribution limits that are determined by the revenues that the business generates. For example, the contribution is typically maxed out at 25% of the payroll.
The Individual 401k is more flexible than the SEP and allows for loans to be taken for emergency situations and even has a contribution makeup plan that allows funds to be continued to catch up to the yearly limit if they are over the age of 50 and need to get their funds caught up.
There are many other options that can be explored when searching for a retirement plan for a small business. However, the best advice that any small business owner can adhere to is to seek the help of a professional accountant or tax consultant. This will ensure that every possible option is explored and that all financial strategies are considered. Professionals who deal in tax codes and laws will be better equipped to point out the advantages and disadvantages of every option.
Small business owners have an important choice to make when putting together a retirement plan, regardless of whether the plan is for their own retirement or for a small group of employees. This decision should be made only after education and due diligence of the many options available.