SEP, SIMPLE, and Solo 401K: Small Business Retirement Savings Plans

Running a small business or being self-employed can offer flexibility, freedom and control over your earning potential. While the perks are plentiful, there’s one thing that’s usually missing when you own a small business: an employer-sponsored retirement plan.

As a small business owner, it’s pretty common that you’re going to be the one wearing many, many hats. While you’re busy running your business on one hand, and juggling everyday life on the other, your thoughts might rarely turn to your retirement. One thing that you might not be taking into consideration is the fact that there are people that heavily depend on you for their future financial health. Investing in small business retirement plans is not only an investment in your employees and business but also yourself.

On the other side of the spectrum, there’s your financial wellness as a business owner. More and more small business owners plan to rely heavily on the success of their business to fund their retirement, which can be risky. Unfortunately, nearly half of small business owners don’t feel well prepared for retirement. It has been found that those who do have a plan in place have larger and more successful businesses, and report higher revenues. Bottom line is that to truly succeed, you have to plan correctly.

Self-employed people don’t have the option of an employer-sponsored plan like a 401K, and small business owners tend not offer them, citing the time and cost to set up and administer them. The good news is there are several other retirement plan options available to small business owners. If you have yet to begin saving for retirement as an entrepreneur, here’s how you can change that.

SEP IRA

The Simplified Employee Pension (SEP) IRA is an excellent choice for the sole proprietor who wants to save for retirement with a minimum of administrative headache. Unlike the Solo 401K, a SEP IRA can cover employees, thus allowing greater scope for business growth. The plan is easy to setup and maintain, and there are no setup fees or annual charges.

These plans are completely employer-funded, and employees make no contributions. For 2021, the employer can contribute up to 25% of compensation to a maximum of $58,000. Note though, that a SEP can become expensive if you want to save aggressively. While you as an employer are not required to make a contribution every year, you must contribute the same percentage for employees that you contribute for yourself.

SIMPLE IRA

The Savings Incentive Match Plan (SIMPLE) IRA allows businesses with fewer than 100 employees to establish an IRA for each employee. Employees are allowed to make salary deferral contributions of up to 100% of compensation, or no more than $13,500 in 2021. Employees over the age of 50 may also make a $3,000 catch-up contribution for a total of $16,500.

The employer also contributes to the account, either matching employee contributions dollar-for-dollar up to 3% of compensation, or contributing 2% of each employee’s compensation. Advantages to this option include easy setup and few administrative burdens.

The contribution limits for a SIMPLE IRA plan are also more generous than those allowed for the traditional or Roth IRA. However, contributions to this account are considered “elective deferrals” that count toward an individual’s overall annual limit on elective deferrals.

Roth IRA

For a sole proprietor, a Roth IRA can be used to supplement retirement savings, provided that income falls under the ceiling of eligibility. It’s possible, for example, to fund a SEP or SIMPLE IRA and a Roth IRA.

Contributions to the Roth IRA are made from after-tax income, and therefore assets held within the account grow tax free. Distributions are tax-free as well. The big drawback to the Roth IRA is that it’s limited on the basis of income and thus not accessible to high earners.

Contributions to the Roth IRA phase out completely for single filers at an annual income of $133,000, and for joint filers at an annual income of $196,000.

When operating a Solo 401K, the contributor essentially has two job titles; the employee and the employer. Contributions can be made on behalf of both roles, so the 401K owner can contribute:

Elective Contributions: Up to 100% of compensation, up to the set limit of $20,500 for 2022, $19,500 for 2021. Catch up contributions for individuals over 50 are set at $27,000 for 2022, and $26,000 in 2021.

Employer Nonelective Contributions: Up to 25% of compensation, or the annual limit of $61,000 for 2022, $58,000 for 2021. Catch up contributions for individuals 50 or over are set at $67,500 for 2022, and $64,500 for 2021.

Defined benefit plan

Best for: A self-employed person with no employees who has a high income and wants to save a lot for retirement on an ongoing basis.

Contribution limit: Calculated based on the benefit you’ll receive at retirement, your age and expected investment returns.

Tax advantage: Contributions are generally tax-deductible, and distributions in retirement are taxed as income. An actuary must figure your deduction limit, which adds an administrative layer.

Employee benefit: If you have employees, you generally offer this plan to them and make contributions on their behalf.

Get started: Your options for brokerages are more limited than with the above accounts, but Charles Schwab offers defined benefit plans.

The details

We often lament the decline of pension plans, and this is exactly that: If you’re self-employed, you can set up your own pension — a guaranteed stream of income — in retirement by using a defined benefit plan.

So why wouldn’t everyone do it? They’re expensive, with high setup and annual fees. If you have employees, that fee will likely go up, and you’ll need to contribute on their behalf. They carry a heavy administrative burden each year, and they require a commitment to fund the plan with a certain amount per year. If you need to change that amount, you’ll pay additional fees.

The upside is that you can stash a lot of cash in these, so if you’re fairly close to retirement, earning a high income that you know you’ll maintain and that allows you to save a significant amount per year — we’re talking $50,000 to $80,000 or more — you might consider using this plan to supercharge your savings efforts.

Shop Around for Plan Administrators

Time is money. Trying to tackle the time commitment of managing the different types of 401(k) plans may not be a realistic option for an already overworked business owner. So, consider outsourcing the administration of your 401(k) and get quotes from several providers.

When interviewing potential small business retirement plan administrators, make sure to ask for these fees, which depend on these five criteria:

  • Size of assets: A percentage of the total dollar amount in the plan. Often, 2% to 3%.
  • Number of employees: A dollar value for each eligible employee or actual participant in the plan.
  • Type of plan: A series of recurring expenses that vary on plan and required number of transactions to execute plan.
  • Fixed cost: A fixed, lump sum applicable to all plans.
  • Setup cost: Cost to set up your plan.

Additionally, don’t forget to ask about the cost to your employee. Every single 401(k) plan administrator charges a percentage fee to plan participants. Make sure that you look out for your employees — studies have confirmed that low investment cost is the only valid predictor of the performance of an investment fund. The lower the investment fee, the better the investment return.

Evaluate all of your possible options because some 401(k) providers offer a small business retirement plan as low as $120 per month plus $4 per month per employee, before potential startup costs. And don’t forget to ask about what costs qualify for the credit of Form 8881.

Are your employees saving enough for retirement?

Making ends meet and saving for retirement at the same time can be a challenge for today’s employees. Many don’t have a plan or haven’t saved even a fraction of what they would need to retire comfortably. We aim to fix that.

As a business owner, you can help start your employees on a path to a better future. A retirement plan with Accuplan is an easy way for them to save money now with the potential to have it grow over the years so they can enjoy retirement.