If you haven't set up a retirement plan for your business yet — or you're not sure the one you have is still the right fit — here are four questions worth working through.
Contribution structure varies by plan type.
A SEP-IRA is funded by employer contributions only, made to separate IRAs for each eligible employee. A SIMPLE IRA blends employee and employer contributions — for example, some employers match up to 100% of the first 3% of employee compensation; others contribute a flat 2% of each eligible employee's compensation. A 401(k) is primarily employee-funded, with the employer having the option to make additional or matching contributions.
Eligibility requirements and vesting schedules can help manage the cost of covering short-tenured employees.
The SEP-IRA covers employees who are at least 21 years old, earn at least $800 in compensation, and have worked for you in at least three of the prior five years. The SIMPLE IRA must cover employees who have earned at least $5,000 in any prior two years and expect to earn $5,000 in the current year. The 401(k) and defined benefit plan must cover all employees who are at least 21 and have worked 1,000 hours in a year, or at least 500 hours per year for two consecutive years.
Vesting is immediate on all SEP-IRA contributions, SIMPLE IRA contributions, and 401(k) employee deferrals. A vesting schedule may apply to 401(k) employer contributions and defined benefit plans.
The SEP-IRA and 401(k) offer higher contribution limits than the SIMPLE IRA. For business owners who are starting their retirement savings later, a defined benefit plan may allow even higher allowable contributions.
The SEP-IRA and SIMPLE IRA are straightforward to establish and maintain. The 401(k) can require more administration, though a Safe Harbor 401(k) can eliminate some of the more complex testing requirements. The defined benefit plan is generally the most complex and expensive option to set up and maintain.
Tax disclosures: Withdrawals from SEP-IRAs and SIMPLE IRAs are taxed as ordinary income; withdrawals before age 59½ may be subject to a 10% federal income tax penalty. Required minimum distributions generally begin at age 73. The same tax treatment applies to 401(k) withdrawals and other defined contribution plans.
If you have questions about which retirement plan makes sense for your business, let's talk.
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Brent Forrest & Associates, LLC. dba Wela Financial Advisory (Wela) is a registered investment adviser. The information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. This article and images may have been enhanced by utilizing artificial intelligence (AI). Wela may discuss and display, charts, graphs, formulas which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. Such charts and graphs offer limited information and should not be used on their own to make investment decisions.
