Does your business offer a retirement plan? Whether you've recently started a business or have been operating one for some time, setting up a retirement plan can be beneficial to both you and your employees. Besides providing tax incentives to defer income and save for retirement, retirement plans can help you reward and retain employees. Employer contributions are tax deductible, within certain limits.
A Simplified Employee Pension (SEP) plan is relatively easy and inexpensive to set up and administer. You have complete discretion in determining whether or not to make annual contributions. To set up a SEP plan, you establish SEP individual retirement accounts (IRAs) for yourself and your employees. Qualifying contributions are tax deductible and not included in the employees' current income. Taxes are deferred until money is withdrawn from the plan.
The maximum amount of your contribution for each employee is the lesser of 25% of annual compensation or $61,000, and no more than $305,000 of compensation may be considered (for 2022). There is a special computation for figuring the maximum contribution to a self-employed individual's own SEP account. Additionally, contributions may not discriminate in favor of highly compensated employees.
A solo 401(k) plan may be a suitable option if you work alone or employ only your spouse. The chief advantage of a solo 401(k) plan is that it allows you to save as both the employee and the employer. As an employee, you may defer the first $20,500 of your compensation (or $27,000 if you're age 50 or older). As the employer, you may also make a profit sharing contribution (subject to tax law limits). The combination of all contributions -- including deferrals, profit sharing, and any others -- may not exceed the lesser of (1) 100% of your compensation or (2) $61,000 ($67,500 if you're age 50 or older). Contribution limits are adjusted annually for inflation.
Like a SEP, a SIMPLE IRA plan entails setting up IRAs for yourself and each participating employee. You and your employees can elect to defer compensation to the plan (no more than $14,000 in 2022; $17,000 if age 50 or older). Additionally, employers must make an annual contribution by either (1) matching employee contributions up to 3% of pay (a lower 1% match is allowed in certain years) or (2) contributing 2% of pay for each employee who's eligible to contribute, even if the employee chooses not to contribute.
A SIMPLE plan generally isn't an option if you have another retirement plan or more than 100 employees.
The chief advantage of a defined benefit plan is the high deduction ceiling, which allows owners to rapidly build up their retirement benefits. For 2022, deductible contributions may allow for an annual benefit that will, when the participant reaches age 65, equal the lesser of $230,000 per year or 100% of the participant's average compensation for his or her three highest consecutive years of active plan participation.
The disadvantages of this type of plan include the funding and administrative requirements. Complicated actuarial formulas must be used to calculate the contributions to be made each year.