401(k) plans are the most popular type of workplace retirement plan in our country. An estimated 53 million U.S. workers participate in 401(k) plans that have total assets of about $4 trillion.
However, SIMPLE IRAs, and SEP IRAs are also popular with for-profit businesses – the typical 401(k) sponsor. These IRA-based alternatives can’t match the high contribution limits or the features breadth of a 401(k) plan, but they can be cheaper and easier to administer.
If you are in the market for a new workplace retirement plan, I recommend you evaluate all three options before you decide to sponsor a 401(k) plan. One of the IRA-based alternatives can be a better choice for your business if your employees won’t utilize a 401(k) plan’s superior benefits.
To help choose the right plan for your business, you should understand their features and match them to your priorities (e.g., higher contributions or simpler administration).
A 401(k) plan is a defined contribution plan where an employee can make contributions from his or her paycheck either before or after-tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan. In some plans, the employer also makes contributions such as matching the employee’s contributions up to a certain percentage. More information about these plans can be found on the IRS website.
Who can offer a 401(k) Plan? Corporations, Sub-Chapter S, Self Employed, Sole Proprietorships, Partnerships, LLCs, and Non-Profit.
|Most valued by highly skilled workers||Administrative costs generally higher than IRA alternatives|
|Highest employee contribution limits - $18,000 + $6,000 catch-up for 2017||More complex ERISA compliance requirements, including annual discrimination testing (non-safe harbor plans only) and Form 5500|
|Highest total contribution limits - $54,000 ($60,000 including catch-up contributions) for 2017|
|Employees can make pre-tax or after-tax (Roth) contributions|
|Most flexible eligibility, contribution, vesting and distribution options|
|Employee loans and hardship withdrawals available|
Allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.
Who can offer a SIMPLE IRA? Employers with 100 or fewer employees who earned $5,000 or more during prior calendar year (cannot maintain another retirement plan).
|Easy and inexpensive to set up and operate||Lower employee contribution limits – $12,500 + $3,000 catch-up for 2017|
|Employees share responsibility for their retirement||Inflexible employer contributions – employer must make either a 3% matching contribution or 2% non-elective contribution|
|No discrimination testing or Form 5500 required||Employer contributions must be 100% immediately vested|
|Employer cannot have any other retirement plan|
A SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP.
Who can offer a SEP IRA? Corporations, Sub-Chapter S, Self Employed, Sole Proprietorships, Partnerships, Non-Profit (not eligible for salary deferral).
|Easy to set up and operate||Employee contributions are not allowed|
|Low administrative costs||Employer must contribute equally for all eligible employees|
|Flexible annual contributions – good plan if cash flow is an issue|
|High contribution limits – Maximum contribution is the lesser of:
- 25% of the employee's compensation, or
- $54,000 (for 2017)
|No discrimination testing or Form 5500 required|
All three of these options offer the following benefits to your business and employees:
- Employer contributions are tax-deductible.
- Tax credits and other incentives for starting a plan may reduce costs.
- A retirement plan can attract and retain better employees.
- Employee contributions can reduce current taxable income.
- Contributions and investment gains are not taxed until distributed.
- Contributions are easy to make through payroll deductions.
- Compounding interest over time allows small regular contributions to grow to significant retirement savings.
For Additional Information:
- Types of Retirement Plans - Overview of IRS rules governing 401(k), SIMPLE IRAs, SEPs, etc.
- Choosing a Retirement Solution for Your Small Business - Overview of retirement plan options and comparison chart (IRS Publication 3998).
- Easy Low Cost Retirement Plans for Your Small Business (webcast) - How to start and operate a low-maintenance retirement plan.