As a small business owner with no employees, you’ve reached a certain level of success and built a comfortable lifestyle for yourself. Business is going well, and now you find yourself thinking about the future and your retirement. How can you better prepare yourself? Establishing a retirement plan for your  small business will help ensure a steady stream of income for you and your family—even after you retire. 

Many types of retirement plans are available to business owners, but a select few are most beneficial to small business owners who have no employees (with the exception of a spouse employee). SEP IRAs,  SIMPLE IRAs, and individual 401(k)s are the most commonly used plan types because of their simplicity, affordability, and minimal administrative requirements. 

Overview of Each Plan Type

To help you determine the best plan for your business, the information below highlights the major benefits of each plan type, as well as important considerations to keep in mind.

SEP IRA

Benefits

• This plan is easy to set up and administer.
• Annual compliance testing and IRS filings aren’t required.
• Contributions are tax-deductible.
• Contributions can vary each year, and they don’t have to be made every year.
• Employers can exclude certain employees, such as anyone younger than 21, those who haven’t been employed for at least three of the past five years, or those who have earned less than $650 in the current year. So, if you decide to hire employees, you may be able to keep this plan type in place until they become eligible without having to contribute.

Important Considerations

• This plan is employer funded. No employee salary deferrals are allowed.
• There is no catch-up provision for those age 50 and older.
• Loans are not allowed.

SIMPLE IRA

Benefits

• This plan is easy to set up and administer.
• Annual compliance testing and IRS filings aren’t required.
• Employer contributions are tax-deductible.
• Employee salary deferrals are allowed and there is a catch-up provision for those age 50 and older.
• Employers can exclude employees who haven’t received at least $5,000 in compensation during any two preceding calendar years (they don’t have to be consecutive years) and who aren’t expected to earn at least $5,000 in the current year. So, if you decide to hire employees in the future, you may be able to keep this plan type in place until they become eligible without having to contribute a match.

Important Considerations

• Employer contributions are mandatory. Employers must make either a nonelective 2% contribution to all eligible employees regardless of participation or match 100% of employee deferrals up to 3 percent of compensation (can be reduced to 1% in two out of five years).
• SIMPLE IRAs have a unique two-year rule associated with their distributions and rollovers. They cannot be rolled over to any other retirement account (except another SIMPLE IRA) within the two-year period beginning on the first date of participation in the plan. In addition, IRA owners younger than 59.5 who distribute within the two-year time frame (without a premature distribution exception) will be fined a 25 percent premature penalty instead of the normal 10 percent penalty.
• Loans are not allowed.

Individual 401(k)

Benefits

• Also referred to as a solo 401(k), this plan has similar features to a traditional 401(k) but without the annual required testing.
• The form 5500 filing isn’t required until assets reach $250,000 or in the year the plan terminates.
• Employer contributions and employee salary deferrals may be tax-deductible to your business or yourself, depending on your business structure.
• There is a catch-up provision for those age 50 and older.
• Loans and Roth contributions are allowed (the adopted plan document will need to allow it).

Important Considerations

• Filing Form 5500 will be required once assets reach $250,000 or in the year the plan terminates.
• Distributions from this plan require a triggering event.
• In comparison with employer-sponsored IRAs, these can require more administrative work such as the use of a plan document and, depending on optional plan features, can be more costly to implement or maintain.

Which Plan Should You Choose?

With so many choices available, it can be difficult to find the right fit. You might start by asking, “What’s most important to me in a retirement plan?” Here are a few points to consider:

• If low cost and minimal maintenance are priorities for your business, and the highest contribution limits aren’t a priority, then a SEP or SIMPLE IRA may be the best fit.
• If you are looking to maximize contributions, a solo 401(k) may be best because it has a salary deferral component, an employer contribution, and a catch-up for people 50 and older. This may be most beneficial if you are over 50 and your income is below the annual compensation cap for the year ($330,000 for 2023 or $305,000 for 2022).
• If you aren’t over 50 and your income is above the annual compensation cap, a SEP may be a better option than a solo 401(k) because maximum contributions will be similar in both accounts and the SEP is easier and likely more affordable to implement.

By understanding what each plan has to offer (and what it doesn’t), you’ll be prepared to make the best choice for your business and your retirement.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Source: Cano Wealth Strategies, LLC