By: Edward Leach, CFP®, MBA
As a business owner, planning for retirement is crucial not only for securing your future but also for attracting and retaining top talent. With various retirement plan options available, it can be challenging to determine which one best suits your needs and the needs of your employees. In this article, we'll explore four popular retirement plans, SEP IRA, SIMPLE IRA, 401(k), and Defined Benefit Cash Balance Plans, to help you make an informed decision.
SEP IRA (Simplified Employee Pension)
Overview:
A SEP IRA is an excellent option for business owners looking for a straightforward and flexible retirement plan. It allows employers to contribute to their own and their employees' retirement savings.
Key Features:
Ease of Setup: SEP IRAs are easy to establish and maintain with minimal administrative requirements.
Contributions: Only employers can contribute to SEP IRAs. Employees cannot make contributions.
Contribution Limits For 2024, employers can contribute up to 25% of an employee's compensation or $69,000, whichever is less.
Flexibility: Contributions are not required every year, providing flexibility in how much you contribute based on your business's financial situation.
Advantages:
High contribution limits compared to traditional IRAs.
Simple to administer with low costs.
Contributions are tax-deductible for the business.
Disadvantages:
No employee contributions are allowed.
Contributions must be the same percentage for all eligible employees, which may have unintended consequences in increasing overhead costs for employees.
SIMPLE IRA (Savings Incentive Match Plan for Employees)
Overview:
The SIMPLE IRA is designed for small businesses with 100 or fewer employees. It allows both employers and employees to contribute to retirement savings.
Key Features:
Ease of Setup: SIMPLE IRAs are easy to establish and maintain with minimal administrative requirements.
Contributions: Both the employer and employees can contribute to the plan.
Employer Match: Employers must either match employee contributions up to 3% of their salary or make a fixed contribution of 2% of compensation for all eligible employees.
Contribution Limits: Employees can contribute up to $16,000 for 2024, with an additional catch-up contribution of $3,500 for those aged 50 and over.
Advantages:
Easy to set up and administer.
Encourages employee participation with matching contributions.
Lower administrative costs compared to 401(k) plans.
Disadvantages:
Lower contribution limits compared to 401(k) plans.
Employer contributions are mandatory.
401(k) Plan
Overview:
A 401(k) plan is a versatile and popular retirement plan option for businesses of all sizes. It allows both employers and employees to contribute.
Key Features:
Ease of Setup: More complex than SEP & SIMPLE IRAs, but with the right plan design and administrators, it can be easy to manage.
Contributions: Both the employer and employees can contribute to the plan.
Employer Contributions: Employers can choose to match employee contributions, which can enhance employee participation and savings, and contribute additional profit-sharing contributions.
Contribution Limits: Employees can contribute up to $23,000 for 2024, with an additional catch-up contribution of $7,500 for those aged 50 and over. Total employee and employer contributions can max out at $69,000 for those under age 50 and $76,500 for those over age 50 for 2024.
Advantages:
High contribution limits.
Flexibility in plan design and employer contributions.
Potential for significant tax benefits for both employees and employers.
Disadvantages:
More complex and costly to administer compared to SEP and SIMPLE IRAs.
Requires adherence to specific regulations and compliance requirements.
Defined Benefit Cash Balance Plans
Overview:
A cash balance plan is a defined benefit plan that defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance.
Key Features:
Predictable Benefits: Employees receive a defined benefit upon retirement, providing certainty and security.
Employer Contributions: Employers credit each participant's account with a set percentage of their salary plus interest.
Investment Risk: The employer bears the investment risk, ensuring that the promised benefits are delivered regardless of market performance, unlike 401(k)s, SEP IRAs, and SIMPLE IRAs, where the investment risk is borne by the employee.
Advantages:
Predictable retirement benefits for employees.
Potential for substantial tax deductions for the business.
Can be attractive for retaining and recruiting top talent.
Disadvantages:
More complex and expensive to administer.
Requires actuarial calculations and regular funding to meet future benefit obligations.
Choosing the right retirement plan for your business is a critical decision that can impact both your financial future and your ability to attract and retain employees. SEP IRAs and SIMPLE IRAs offer simplicity and ease of administration, while 401(k) plans and Defined Benefit Cash Balance plans can provide higher contribution limits and greater flexibility but come with higher administrative complexity.
Please consult your Advisor at HIGHLAND if you are considering a retirement plan for your business. With the right plan in place, you can ensure a secure and prosperous retirement for yourself and your employees.
Ed Leach, CFP®, MBA, is a Partner and Wealth Advisor at HIGHLAND Financial Advisors, LLC in Wayne, NJ, and works directly with clients advising them on their financial planning and investments. Ed’s work focuses on the unique needs of business owners, helping them extract value from their businesses while creating efficiencies in their business and personal financial plans. He is also a member of NAPFA, which is dedicated to serving fee-only advisors.