What are retirement plans for small business owners?

Answer:   In terms of qualified retirement plans that incorporate an IRA, a SEP-IRA or SEP plan offers the greatest tax benefits to small business owners, but small business owners and their employees have a variety of retirement plan options. For example, there are several different types of IRAs: Traditional IRA, Roth IRA, Education IRA (EDIRA), now called Education Savings Accounts, SEP-IRA, SARSEP-IRA, and SIMPLE-IRA. Traditional and Roth IRAs typically have the lowest contribution maximums ($5,000 for those younger than 50 and $6,000 for those age 50 and older in 2009) so when considering tax deductible IRAs, business owners usually evaluate SEP, SARSEP and SIMPLE IRAs before settling on Traditional or Roth IRAs. Retirement plan eligibility and contribution limits differ depending on the type of plan, but in order to make tax deductible contributions you typically must have earned income or compensation from a trade or business. Earned income generally consists of wages or salary from a job or your own business or self-employment income generated from performing services in your own business. Provided you have earned income and meet any other IRS requirements, you can generally make tax deductible contributions to a retirement plan.

Retirement plans offer business owners a way to legally channel funds from their businesses, without taxes, into retirement savings programs for themselves and their employees. Generally, traditional pension plans, or defined benefit and money purchase plans, which are often difficult to establish and maintain and have mandatory funding requirements, are not favored by small business owners. More often 401(k) plans, SEP plans (Simplified Employee Pension), SIMPLE plans (Saving Incentive Match Plan for Employees), and Keogh plans and Traditional IRAs, are favored by self-employed small business owners; however, new vehicles such as Solo 401(k)s have been gaining in popularity.

In terms of SEP, SARSEP and SIMPLE plans, in order to make tax deductible contributions to a SARSEP, the plan must have been established before 1997, so they are not an option for new employers.  As to SEP and SIMPLE plans, a SEP plan has a higher contribution limit than a SIMPLE. SEP plans are generally favored by self-employed business owners who do not have any employees; however, both types of plan can be established for businesses with employees and both will allow for employer contributions provided the business owner(s) or employees have earned income from the business. In terms of employee salary reduction or deferral contributions, employee contributions are not permitted under an SEP plan but are permitted under a SIMPLE plan. Also, a SIMPLE plan will generally allow for greater contributions than an SEP plan when a business owner’s or employee’s earned income from the business is below a certain amount. 

Ultimately, your business entity structure (corporation, LLC, partnership, sole proprietorship) and other considerations, including your expected income from the business, cash needs for other benefits such as health insurance, and your own lifestyle, income and retirement planning goals, will affect your choice of plan(s). Your first step should be to sort out your options and familiarize yourself with each type of plan and its respective pros and cons, including contribution limits, set-up, maintenance and administrative costs, and investment and distribution options. You can locate numerous discussions on retirement plans for self-employed small business owners, retirement planning and tools with an Internet search engine. The following are example websites:

• Self-Employed Retirement Plans: about.com
• Keogh Retirement Plans: money-zine.com
• Certain Employee Benefit Payments Are Tax Deductible: toolkit.com
• 401k Plans for Sole Proprietorships: 401khelpcenter.com
• Solo 401k: 401ksolo.com
• Choosing a Retirement Solution for Your Small Business: irs.gov
• Retirement Plans for Small Business: irs.gov

Also, mutual fund companies, brokerage firms, banks and insurance companies offer information on small business retirement plans. For example, T. Rowe Price and Vanguard, both mutual fund leaders, offer considerable retirement planning information which you can review at the following websites:

• Small Business Retirement Plans: individual.troweprice.com
• Small Business Retirement Plans: personal.vanguard.com

When selecting a retirement plan option for their business and for general tax planning, we recommend business owners consult a local tax advisor, CPA, and/or financial planner to help them weigh their retirement plan options and select a plan that meets their business and personal financial and retirement planning goals.