When deciding on a retirement plan for your business, the number of available options can be overwhelming. Each plan has its benefits, but it is important to understand which is most suitable for your particular situation. The retirement plans detailed within can help you determine which plan is most appropriate for your business and its employees.
A 401(k) plan is a retirement plan under which an employee can elect to have their employer contribute a portion of their wages to a retirement account. The wages contributed are known as “elective deferrals” and are not subject to federal income tax at the time of deferral.
The main tax advantages of sponsoring a 401(k) plan are:
- Employer contributions are deductible on the employer’s federal income tax return to the extent that the contributions do not exceed certain limitations.
- 401(k) contributions and investment gains are tax deferred until distribution in retirement.
The maximum employee contribution that can be made to the plan is $18,500 for 2018. For those employees over 50 years of age, a $6,000 additional catch-up contribution can be made. Employee elective deferrals must be made by the end of the year to be included on that tax year’s W-2. Employer nonelective matching contributions can be made up to 25% of compensation or for self-employed individuals net earnings from self-employment after deducting one-half of your self-employment tax and can be made until the extended due date of the employer’s tax return.
There are several types of 401(k) plans available to employers including traditional 401(k) plans, safe harbor 401(k) plans, and SIMPLE 401(k) plans. Below is a brief description of each type.
1) Traditional 401(k) Plan
A traditional 401(k) plan allows eligible employees to make pre-tax contributions through payroll. In a traditional 401(k) plan, employers have the choice to make contributions on behalf of all participants, make matching contributions based on employees’ contributions, or both.
2) Safe Harbor 401(k) Plan
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, however, employer contributions must be fully vested when made. The safe harbor 401(k) plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401(k) plans. In addition, safe harbor 401(k) plans that do not provide any additional contributions in a year are exempted from the top-heavy rules of section 416 of the Internal Revenue Code. Both the safe harbor and traditional 401(k) plans are for employers of any size and can be combined with other retirement plans.
3) SIMPLE 401(k) Plan
The SIMPLE 401(k) plan was formed so that small businesses could have an efficient, cost-effective way to offer retirement benefits to their employees. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the previous calendar year. Employees who are eligible to participate may not receive any contributions or benefit accruals under any alternative plans of the employer and are limited to a $12,500 elective deferral with a $3,000 catch up contribution.
4) Solo 401(k) Plan
The Solo-k plan is just a traditional 401(k) plan covering a business with no employees which can include the business owner’s spouse. One advantage to this plan is the employee elective deferral can be made dollar for dollar with compensation or earned income up to the deferral limitations allowing for a larger contribution with smaller amounts of income. Additionally, this plan is not required to file a Form 5500 until assets exceed $250,000 and even then it files a shorter Form 5500-SF.
Simplified Employee Pension (SEP) plans are easy to set up and maintain, as they do not have the start-up and operating costs of a conventional retirement plan. Any employer with one or more employees is eligible to provide them, and it is commonly seen with sole proprietorships for its flexibility and simplicity.
In 2017 and 2018, the maximum contribution to a SEP is the lesser of $54,000 or 25% of the employee’s salary. Contributions for each year must be made no later than the extended due date of the employer’s tax return. Annual contributions can be flexible, making this a good plan if cash flow is an issue from one year to the next. If the employer plans to contribute anything to an employee’s SEP, they must contribute equally for all employees that are eligible.
SIMPLE IRA plans can offer a substantial source of income for retirement by permitting both employers and employees to set aside money in retirement accounts. An advantage of a SIMPLE IRA is that it does not have the start-up and operating costs of a conventional retirement plan. It is available to any small business with 100 or fewer employees. Under a SIMPLE IRA, an employer is required to annually contribute either a matching contribution of up to 3% of compensation or a 2% nonelective contribution for each eligible employee.
In 2018, the maximum that can be contributed to a SIMPLE IRA is $12,500, with an additional $3,000 allowed for those employees over 50 years of age. SIMPLE IRA employee contributions can be made no later than 30 days after the close of a month for which the contributions are made and employer match contributions are required by the extended due date of the employer’s tax return.
Choosing the best type of retirement plan for your business can be very complex. Please contact your L&B professional at 858-558-9200 to further discuss the best option for your business.