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January 17, 2022 | investment

Small Business Retirement Plans

Katie Duncan

Finance Writer

Retirement planning can be a daunting subject for self-employed individuals and small businesses. There’s a lot of confusion about who is eligible for what plan, or how a small business could even afford to support a retirement plan. Even after you decide your business can support it, there’s a sea of choices to sort from, which may leave you wondering, “Which one is actually best?”

The IRS states that people may need up to 80% of their current income after retirement to keep up with their cost of living. If you haven't established a retirement savings plan yet, it’s never too late. Here’s what you should know about getting started.

Why should you invest in a small business retirement plan?

Whether you’re a freelancer or a business owner, a retirement account or plan allows you and your employees to save for the future. Investing in one of these retirement plans can have significant advantages:

  • Many retirement accounts are tax-advantaged, meaning your contributions are tax-deductible and grow tax-deferred or they grow tax-free, depending on the type of retirement plan.
  • Retirement accounts take advantage of compound interest, producing earnings on earnings.
  • There are heavy penalties for early withdrawal, so these accounts can take away the temptation to dip into the account for non-essential expenses.

Small-business owners can also reap the benefits of offering retirement savings opportunities to employees.

  • Contributions that employers make toward the retirement accounts of employees are tax-deductible.
  • Your business may be eligible for a tax credit for establishing a qualified retirement plan.
  • Retirement plans are a valuable benefit that can attract and retain employees.

Though it’ll take a little work to get everything started, retirement plans are well worth it for everyone involved.

Small Business Retirement Plan Options

Retirement plans usually fall under one of two categories: IRA-based plans or qualified plans.

Qualified plans— such as 401(k)s, profit-sharing plans, and defined benefit plans— are generally more complicated and expensive to maintain than IRA-based plans like SEPs and SIMPLE IRAs. This is because they have to comply with specific Internal Revenue Code and ERISA (the Employee Retirement Income Security Act of 1974) requirements in order to qualify for their tax benefits.

Also, qualified plan assets must be held either in trust or by an insurance company. With IRA-based plans, your employees own (i.e., are "vested") your company’s contributions to their accounts immediately. With qualified plans, you can generally require that your employees stay with your company for a certain number of years before they can keep company contributions.

Which is the best retirement plan for your business?

Your retirement plan can include a range of options, not just a single type of retirement account. You’ll also have to consider the rules that will guide contributions and eligibility.

You'll need to clearly define your goals before attempting to choose a plan. Think about the features you want your employer-provided retirement plan to have. Your overall plan could possibly:

  • Include contributions from the employees and your company
  • Allow you and your employees to make pre-tax contributions
  • Include 401(k) and traditional Roth IRA options
  • Not include any qualified plans, and instead focus on setting your employees up with self-managed plans
  • Have the flexibility to skip employer contributions in years of financial hardship
  • Include low-cost options
  • Have a higher management fee but be more convenient overall
  • Have a lower cost but involve more hands-on maintenance

The answers to these questions can help guide you and your retirement professional to the plan (or combination of plans) most appropriate for you. Here are five of the most popular small business retirement accounts.

1. SEP IRA Plans

A simplified employee pension (SEP) is a type of IRA that employers or self-employed individuals can establish. Sole proprietors, partnerships, and corporations are eligible to participate.

SEP-IRA Quick Facts

Who contributes to this plan?

Only employers contribute to SEP-IRAs.

What is the annual contribution limit?

Annual contribution limits vary from year to year.

For 2022, your contributions for each employee are limited to the lesser of 25% of pay or $61,000.

Is it tax-advantaged?

SEP-IRA contributions are tax-deductible for employers. Investments grow tax-deferred until retirement.

Can you skip yearly contributions?

Yes. You are not required to fund a SEP IRA every, but if you do make contributions, you must contribute to your own SEP-IRA, as well as the SEPs of all eligible employees.

Are employees immediately vested in contributions?

Yes. Any contribution you make immediately belongs to the employee.

Employers contribute a uniform percentage of pay for each employee, although you don't have to make contributions every year, offering you some flexibility when business conditions vary.

SEP IRAs have low start-up and operating costs and can be established using an easy two-page form. Employers do not make investment decisions; instead, an IRA trustee determines eligible investments and employees make investment decisions. Trustees also take care of annual statements, contribution deposits, and filing required documentation with the IRS.

2. SIMPLE IRA Plan

A Savings Incentive Match Plan for Employees— or SIMPLE IRA for short— is a tax-deferred retirement plan that is available if you have 100 or fewer employees.

SIMPLE IRA Quick Facts

Who contributes to this plan?

Employees and employers can contribute to a SIMPLE IRA.

What is the annual contribution limit?

Annual contribution limits vary from year to year.

For 2022, the contribution limit for employees is $14,000. Employees over 50 years old can make catch-up contributions of $17,000.

Employers must either match your employees' contributions dollar for dollar — up to 3% of each employee's compensation — or make a fixed contribution of 2% of compensation for each eligible employee.

Is it tax-advantaged?

Like a traditional IRA, contributions are tax-deferred meaning that your taxable income is reduced the year that you contribute.

Can you skip yearly contributions?

Employer contributions are mandatory, however the 3% match can be reduced to 1% in any two of five years.

Are employees immediately vested in contributions?

Yes. Any contribution you make immediately belongs to the employee.

SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs are set up for each employee. A financial institution can do much of the paperwork. Additionally, administrative costs are low.

3. Profit-Sharing Plan

A profit-sharing plan is a type of retirement plan that gives employees a share in company profits based on quarterly or annual earnings. Employers decide how much of the company profits that it wishes to share with employees.

Profit-Sharing Plan Quick Facts

Who contributes to this plan?

Only employers contribute to profit-sharing plans.

What is the annual contribution limit?

For 2022, the maximum contribution amount is the lesser of 100% of compensation or $61,000.

Is it tax-advantaged?

Profit-sharing contributions are tax-deductible for employers.

Can you skip yearly contributions?

Yes. Profit-sharing plans can be adjusted as needed, meaning that employers may make no contributions in some years.

Are employees immediately vested in contributions?

Internal Revenue Code provides three vesting schedules for profit-sharing plans: immediate vesting, two- to six-year graded, or three-year cliff vesting.

Employer contributions are discretionary — there's usually no set amount you need to contribute each year, and you have the flexibility to contribute nothing at all in a given year if you so choose. However, in order for your plan to remain qualified, your contributions must be nondiscriminatory, and "substantial and recurring”.

The plan must contain a formula for determining how your contributions are allocated among plan participants. A separate account is established for each participant that holds your contributions and any investment gains or losses.

Generally, each employee with a year of service is eligible to participate (although you can require two years of service if your contributions are immediately vested).

4. 401(k) Plan

The 401(k) plan (technically, a qualified profit-sharing plan with a cash or deferred feature) has become a hugely popular retirement savings vehicle for small businesses. There are two types: traditional (pre-tax contributions) and Roth (after-tax contributions.

401(k) Quick Facts

Who contributes to this plan?

Both employees and employers can contribute to a 401(k).

What is the annual contribution limit?

Employees can contribute up to $20,500 (or $27,000 for people over 50) per year.

Combined employer and employee contributions for any employee can't exceed the lesser of $61,000 (or $67,500 for people over 50).

Is it tax-advantaged?

401(k) contributions are tax-deferred meaning that your taxable income is reduced the year that you contribute.

Roth 401(k)s contributions are made with after-tax dollars, but income earned on the account is tax-free.

Can you skip yearly contributions?

Traditional 401(k) plans do not require employer contributions and are allowed to discontinue or reduce contributions plan-wide.

Are employees immediately vested in contributions?

Internal Revenue Code provides three vesting schedules for 401(k)s: immediate vesting, two- to six-year graded, or three-year cliff vesting.

In general, each employee with a year of service is eligible to receive employer contributions, but you can require two years of service if your contributions are immediately vested.

401(k) plans are required to perform somewhat complicated testing each year to make sure benefits aren't disproportionately weighted toward higher-paid employees. However, you don't have to perform discrimination testing if you adopt a "safe harbor" 401(k) plan. With a safe harbor 401(k) plan, you generally have to either match your employees' contributions up to a certain amount or make a fixed contribution of 3% of compensation for all eligible employees, regardless of whether they contribute to the plan.

Self-employed individuals with no employees (except a spouse) may opt to contribute to a Solo 401(k).

5. Defined Benefit Plan

A defined benefit plan is a qualified retirement plan that guarantees your employees a specified level of benefits at retirement (for example, an annual benefit equal to 30% of final average pay). As the name suggests, it's the retirement benefit that's defined, not the level of contributions to the plan.

Defined Benefit Plan Quick Facts

Who contributes to this plan?

Generally, employers are responsible for contributions. In some cases, employee contributions are required or voluntary contributions may be permitted.

What is the annual contribution limit?

In 2022, a defined benefit plan can provide an annual benefit of up to $245,000 (or 100% of the participant’s average compensation, whichever is less).

Is it tax-advantaged?

Employer contributions up to the maximum annual limit are tax-deductible and investment gains are tax-deferred.

Can you skip yearly contributions?

Employer contributions may vary from year to year, depending on the performance of plan investments and other factors

Are employees immediately vested in contributions?

Vesting can follow a variety of schedules from immediate to spread out over seven years.

If you choose a defined benefit plan, the services of an actuary are generally needed to determine the annual contributions that you must make to the plan to fund the promised benefit.

The downside to defined benefit plans is that they can be costly and complex. This means that they are not the best retirement plan for most small businesses. However, because they can provide the largest benefit of any retirement plan and therefore allow the largest deductible employer contribution, defined benefit plans can be attractive to businesses that have a small group of highly compensated owners who are seeking to contribute as much money as possible on a tax-deferred basis.

Explore Retirement Plans for Small-Business Owners

As an employer, you have an important role to play in helping your workers save for retirement. Now is the time to look into your options to find the best retirement plan programs for you and your employees. The more you save now, the more time you and your employees’ retirement plans will have to grow.

* Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

Before deciding whether to retain assets in an employer-sponsored plan or rollover to an IRA an investor should consider various factors including but not limited to: investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Before you elect to open an IRA account and engage your investment representative, please review all account statements and disclosure documents related to the IRA and services to be provided under a new relationship and consult with a qualified tax advisor as needed. If transferring an existing retirement plan into an IRA, you should be aware that (i) Those assets will no longer be subject to the protections of ERISA (if applicable) (ii) depending on the investments and services selected for the IRA, you may pay more or less in transaction costs than when the assets are in the Plan, (iii) if you are between the age of 55 and 59 ½, you would lose the ability to potentially take penalty-free withdrawals from the plan, (iv) if you continue working past age 70 ½ and transferred your plan assets to a new employer’s plan, you would not be subject to required minimum distribution and (v) withdrawing assets directly would be subject to federal and applicable state and local taxes and possibly be subject to the IRS penalty of 10% if under age 59 ½.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.

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