If you want to be prepared for your retirement, you probably need to contribute to a retirement plan as you run your business. There’s always the option of stashing away cash in a traditional IRA or a Roth IRA. However, there are a handful of retirement plans that work especially well for small-business owners. Solo 401(k)s can work well for super savers, while SEP IRAs are a straightforward retirement vehicle with relatively high limits. If you also want to contribute on behalf of your employees, a SIMPLE IRA offers flexibility.
Here’s a rundown on these three options.
How it works: As an employer, you can contribute $53,000 for 2015 or 25 percent of your compensation — whichever is less — as a business tax deduction to a Simplified Employee Pension (SEP) IRA. Investment earnings grow tax free.
- There’s no IRS reporting for SEP IRAs, setup is easy, and there’s no annual funding requirements.
- You can establish the plan and make contributions as late as April 15 of the next tax year. By contrast, the deadline is December 31 for solo 401(k) plans.
- You can contribute to both a SEP IRA and an employer-sponsored retirement plan.
- You may be required to contribute for employees. Fidelity’s SEP IRA, like others, requires that each eligible employee receive the same contribution percentage of compensation.
- If your compensation is less than $212,000, you could get a higher contribution limit with a solo 401(k).
- Doesn’t allow catchup contributions for employees over 50.
Bottom line: SEP IRAs are great for moonlighters who still want to contribute to another plan. They’re also a good option for freelancers without employees who want a no-fuss plan, and they’re best for individuals who don’t want to contribute more than 25 percent of their income toward retirement.
How it works: For 2015, you can make up to $18,000 in tax-deferred contributions as an employee, plus contribute up to 25 percent as an employer. Your total contribution cannot exceed $53,000 in the year.
- Some brokers, like Vanguard, offer a Roth 401(k) option that allows you to use post-tax instead of pretax dollars to fund the plan.
- Solo 401(k)s allow for catch up contributions, meaning you can contribute $24,000 instead of $18,000 if you’re over 50.
- Spouses can also contribute.
- Business owners with employees are not eligible. If you take on employees, you’ll have to convert the plan to a group 401(k).
- Once the plan has more than $250,000 in it, you must file an annual Form 5500 with the IRS.
- Compared to a SEP IRA, account setup and contribution timing rules are more complex. Maintenance fees can also be more expensive.
Bottom line: It’s the best option if you want to stash away a large percentage of your income, as long as you don’t mind dedicating a little more time and money to setup and maintenance.
How it works: For 2015, employees can contribute up to $12,500 tax-deferred. Employers can match up to 3 percent of employee salaries.
- No annual Form 5500 is required.
- There’s no minimum contribution for employees.
- Unlike the SEP IRA, you can customize contributions for different employees.
- Allows for catch up contributions, so employees over 50 can contribute $15,500 a year rather than $12,500.
- As an employer, you must offer a minimum match or contribution to employees. It’s customary to offer a 3 percent match, although you can dip down to as low as 1 percent for two out of any five years. Alternatively, you can contribute 2 percent of employee compensation for all eligible employees.
- Plan must be established by October 1 of the tax year.
- According to USAA, employer contributions must be made within 30 days of the employee contribution.
- Limited to companies with less than 100 employees, which means you may need to upgrade plans down the road.
Bottom line: SIMPLE IRAs are a great way to fund employee retirement plans and offer flexible contributions and matching. But if don’t plan on taking on employees, you can probably snag a higher contribution limit (and endure fewer rules) with a SEP IRA.