As a small business owner or someone who has decided to stay on at a small business for the long haul, knowing your options for a small business retirement plan is vital. This is how you plan for your future in your post-work years. So, pay attention as we outline the main options below.
What is a small business retirement plan?
A small business retirement plan is a retirement plan specifically designed for smaller businesses to implement and administer with minimal expense and maximum ease. After all, there's always a lot going on with a small business, so retirement plans can't take up too much time.
Fortunately, these days, there are lots of options for small business owners and their employees. From individual retirement accounts (IRAs) to 401(k)s and even pension plans, small business retirement plans appear in every shape and size.
IRAs are common options for small businesses to offer their employees because they are both easy to set up and inexpensive to administer. There are several types that are good for small businesses, but these are the most common:
Payroll deduction IRA
Payroll deduction IRAs require no special filing on the part of the small business owner but can provide employees a way to divert some of their income directly into their IRA. Rather than the employee setting aside money for deposits, payroll deduction IRAs just take a percentage of each paycheck and deposit it on the employee's behalf. Employers cannot contribute to these IRAs.
SEP IRA
Simplified Employee Pension (SEP) IRAs are the opposite of payroll deduction IRAs but also require no filing or complicated steps. They only accept employer contributions on behalf of the employee and cannot accept employee contributions. Contributions are immediately 100% vested for the employee in question.
SIMPLE IRAs
SIMPLE IRAs require a very small amount of paperwork but provide the best of both worlds between the two plans above. Both employees and employers can contribute, and contributions are immediately vested for the employee.
Small business 401(k)s
Small businesses can now offer their employees 401(k)s as easily as they offer IRAs. All small business 401(k)s function like those available elsewhere for the employee, with options for employers to match employee contributions and automatic payroll deductions.
Traditional small business 401(k)s are exactly as you'd expect, with features like employer contributions that become vested over time and employee contributions that are vested immediately. They can be either opt-in, meaning the employee has to elect to open the 401(k) and start contributions, or opt-out, meaning the employee is automatically enrolled unless otherwise specified.
Traditional 401(k) plans require annual testing to ensure they do not discriminate in favor of more highly compensated employees. Safe Harbor 401(k)s, on the other hand, do not require annual testing, which is why they are often the choice of very small businesses that must keep their retirement plans simple. They do require employer contributions, and all contributions are 100% vested immediately. Otherwise, they behave just the same as any 401(k).
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Small business defined-benefit plans
Although pensions are increasingly rare in the workplace, they are still an option for small business retirement plans. Also known as defined-benefit plans because the benefit is defined prior to the employee joining the company, pensions can require additional outside help to establish and maintain, especially regarding how much contribution is necessary each year.
Pension
Employers primarily fund defined-benefit plans, and the contribution is calculated based on the pension's final value. These plans may require some time to vest before the employee can access them and may or may not permit loans against them.
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