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401(k) Options for Small Business Owners

401(k) Options for Small Business Owners

March 01, 2024

Regardless of the business's size, small business owners have 401(k) retirement savings plan options that may be suitable for their situation. Business owners must plan for retirement by utilizing retirement savings vehicles that may provide them with common IRS tax savings incentives when funding specific 401(k) options.

A business owner can open several retirement savings plan types if they're the only employee or have anywhere from two to 100 employees. As you work with your financial and tax professionals to determine which is appropriate for your small business, we outline what to know about each:

Solo 401(k)- A solo 401(k) is a retirement savings plan for self-employed business owners who want to maximize their retirement contributions. It's also called an individual 401(k) or i401(k). Here are other things specific to this plan:

  • Only the business owner and their spouse can participate in this plan.
  • Contributions are made in two ways: employee elective-deferral contributions and profit-sharing contributions.
  • The plan may offer loans, depending on the plan documents.
  • There is no nondiscrimination testing, which would determine who may or may not participate.
  • Contributions may be up to 25% of eligible compensation.
  • Contributions are made pretax; the business contribution is tax-deductible to the business.
  • Participant withdrawals are taxed as regular income and if withdrawn before age 59 1/2 may be subject to ordinary income taxes in addition to a 10% penalty.

Traditional 401(k)- This retirement savings plan allows employees to contribute a higher dollar amount and take loans if the plan document allows. Traditional 401(k)s may include pretax and Roth 401(k) contributions. Traditional 401(k) plans also have IRS limits on what the employee can contribute:

The 2023 contribution limits are $22,500 or $30,000 for employees aged 50 and older. Employers can contribute up to 25% of the employee's compensation, but the employee and employer contribution totals must not exceed $66,000 or $73,500 for employees aged 50 and older. Here are other things to know about traditional 401(k) plans:

  • Employee contributions are made to the 401(k) with pretax dollars and into the 401(k) Roth with after-tax dollars.
  • The business's 401(k) and 401(k) Roth contributions are tax deductible.
  • The plan requires nondiscrimination testing.
  • 401(k) plans are for businesses with two or more employees that are not owner-employees.
  • Participant distributions taken before age 59 1/2 may be subject to ordinary income taxes in addition to a 10% penalty.

Simplified Employee Pension (SEP) IRA- A SEP IRA is an individual retirement account (IRA) that a business or a self-employed person can establish. Contributions are discretionary, meaning there is a choice to contribute. Here are other things about SEP IRAs:

  • The business or the self-employed person contributes.
  • IRA contributions are made pretax and are a deduction to the business, which may help lower taxes.
  • SEP IRA annual contribution limits may be higher than standard IRAs and 401(k)s.
  • Participant withdrawals are taxed in the year received and if withdrawn prior to age 59 1/2 a 10% additional tax generally applies.

SIMPLE (Savings Incentive Match Plan for Employees of Small Employer) IRA- A SIMPLE IRA plan is for businesses with less than 100 employees who earned $5,000 or more during the previous calendar year. The business cannot have another retirement plan to have a SIMPLE plan. Here are other things specific to a SIMPLE plan:

  • Employees make contributions with pretax dollars.
  • Employees are subject to the IRS annual contribution limits.
  • The business may or may not choose to make contributions.
  • The business may receive a tax credit for establishing a SIMPLE plan.
  • Distributions by a participant are generally subject to income tax upon withdrawal and if withdrawn prior to age 59 1/2 a 10% additional tax applies. (The additional tax increases to 25% if withdrawal occurs within 2 years of beginning participation in the plan.)

Small business owners should consider establishing a retirement plan because it may help them be more financially confident in retirement. A retirement plan may also help attract and retain qualified employees and offer business tax savings.

Small business owners must meet with their financial and tax professionals to determine which plan suits their situation and how it may help reduce their overall tax burden.




Important Disclosures:

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by Fresh Finance.

LPL Tracking #1-05375334

Sources:

https://www.investopedia.com/retirement/401k-plans-small-business-owner/

https://www.irs.gov/pub/irs-pdf/p3998.pdf  (found on this IRS site- https://www.irs.gov/retirement-plans/retirement-plans-for-small-entities-and-self-employed)

https://www.investopedia.com/terms/s/sep.asp

https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/simple-ira-plans-for-small-businesses.pdf