What are the 401 (k) and Small Business IRA Options?

by Mahesh V. SEO analyst

As a small business owner, hiring and retaining the right employees is important to your business. Retirement plans can be a valuable tool in attracting those employees and offering them a way to plan for their future. Whether it's an Individual 401 (k) plan, a SIMPLE IRA, a SEP IRA, or a Safe Harbor 401 (k), opening a small business 401 (k) can mean stepping in the right direction.

What are Individual 401 (k) Plans?

As a small business owner, you may have retirement benefits similar to those offered by large companies. If you and your spouse run a small business without an employee, a simplified 401 (k), called an Individual 401 (k) plan, maybe a good option to help them work toward their retirement goals.

What are the benefits of an Individual 401 (k) plan for business owners?

This type of plan may allow the owner and their spouse to protect more of their income from taxes than other types of retirement plans allow.
The business owner may have the ability to contribute larger amounts to this type of plan than to other corporate retirement plan options.
Contributions to the plan may be deductible from company taxes.
The business owner may be able to borrow a portion of the account balance using a loan provider in case of financial hardship.
Contributions to the plan are flexible and could include elective deferrals before taxes, designated Roth contributions after taxes, profit or discretionary distributions, and reinvestment contributions.
The owner may contribute up to 25% of eligible income to the plan as a discretionary contribution or profit-sharing.
Elective deferral limits are periodically adjusted by the Internal Revenue Service (IRS), including the additional elective deferral amount for participants age 50 and older.

What are the eligibility requirements for an Individual 401 (k) plan?

An Individual 401 (k) plan is available to companies established as a self-employed company, partnership, Limited Liability Company (LLC) or incorporated, including a Subchapter S corporation.
Companies that are determined as part of a controlled group of companies are not eligible.
The deadline to establish a plan is the last day of the fiscal year. For a business calendar year, the deadline is December 31.

What is a Safe Harbor 401 (k) plan?

A Safe Harbor 401 (k) plan allows an employer to offer a retirement plan, regardless of salary. And you can generally allow participants, including business owners, to put more money aside than in other types of retirement plans, which have lower limits on total annual contributions. The Internal Revenue Code and related regulations allow a Safe Harbor 401 (k) plan to not discriminate against employees based on income, even if the owner is the only contributing employee.

This plan allows eligible employees to contribute part of their salary, either before or after-tax, as a designated Roth contribution. To satisfy Safe Harbor requirements, the employer is required to make an equivalent or non-optional contribution for all eligible employees.

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The first requirement for a Safe Harbor 401 (k) plan is that all eligible employees be allowed to participate.

An eligible employee is defined as someone who:

You are over 21 years of age.
You have served for at least one year, and
You have worked at least 1,000 hours in the year from the date of hire.

An employer can make the plan more inclusive, for example, by covering younger employees or allowing employees who have been with the company for less than a year to participate.

What are the requirements for a Safe Harbor 401 (k) plan?

Employer Contributions - An employer is required to make a contribution to Safe Harbor 401 (k) plans. The employer can do it:
- Contributing a minimum of 3% of the salary of all eligible employees.
- Or the employer can match the deferred contributions to the wages of all eligible employees.
- An example of this would be if an eligible employee differs by 5% of salary (for example, from compensation), then the employer is required to match it with a contribution of 4% of the employee's compensation. This is calculated with a basic formula in which:
  - The employer contributes 100% of deferred salary contributions representing the first 3% of compensation.
  - Plus an additional 50% of deferred salary contributions representing the next 2% of compensation.

100% Benefit from Required Employer Contribution - The required employer contribution to Safe Harbor is a benefit enjoyed at 100% immediately. Employees can take that money with them when they stop working for the company, no matter how long they've worked there.
Annual Notice to Participants - Every year the employer must provide a notice that explains the contributions of Safe Harbor and how the employer will meet those requirements.
Deadline to establish a plan - A new plan must be established before October 1 of the applicable year (assuming it is a calendar year plan).

What is a SIMPLE IRA plan?

An Employee Savings Incentive Match Plan, known as the SIMPLE IRA, is a relatively simple way for small businesses to add a retirement plan to their employee benefits.

How does a SIMPLE IRA for employees to work?

Each eligible employee establishes an IRA and may choose to make pre-tax deferrals of their paychecks. Employers may make a non-optional payment of 2% of compensation to each employee eligible for this plan. Or the employer could match individual contributions up to 3% of compensation for each employee per year. All employees must receive the same percentage of compensation, either the non-optional contribution or the employer-matched contribution. The employer may change the percentage from year to year, but certain restrictions apply.
Participants immediately benefit from 100% of the account value, meaning that all funds belong to eligible employees from the time they are deposited.
Your contributions as an employer may be tax-deductible.
Participating employees also do not have to pay income taxes they contribute. however, they may owe taxes if they make withdrawals. For more, see here.
Investment earnings that employees have will be accumulated with deferred payment of taxes until their retirement.

Who is eligible for a SIMPLE IRA?

Eligible employees must have received at least $ 5,000 of annual income from the company in any of the two years prior to the current year and are reasonably expected to earn at least $ 5,000 in the current year. An employer can set less restrictive requirements (for example, allow all employees to participate, even those who earn less than $ 5,000) but cannot put more restrictions.
This plan is for companies with less than 100 employees. If the company grows and the employer hires more than 100 people, the plan can continue for two more years; then it has to be dissolved.

What is a Simplified Employee Pension Plan or SEP IRA?

The Simplified Employee Pension Plan or SEP IRA is a small business retirement plan that is easy to create. Eligible employees create their SEP IRA, in which tax-deductible contributions are made only by the employer. The contribution percentage can vary each year, from 0 to 25% of the compensation. The same compensation percentage must be provided for all eligible participants, including the owner-employee.

A SEP plan must be available to all employees who are at least 21 years of age and who have served the employer for three of the past five years.
Employers have the option to offer the plan to more people; for example, to all employees.

The employer can deduct all contributions made to the plan and they are not considered taxable for employees (although when employees make withdrawals from their accounts they will owe taxes). Also, any investment gain is with deferred payment of taxes until your retirement.

The SEP plan is a tax-deductible way for small business owners to attract and retain employees while also saving for their own retirement; after all, the owner is generally an eligible participant.

Offering retirement plans is a great way to attract and retain employees. As a business owner, you have many options.