Whether you are a one person sole proprietor or a larger corporation, having a retirement plan for you and/or your employees is an important planning tool and benefit. Not only is it possible to reduce your income tax burden, but you potentially could build a sizable nest egg over time to help fund your retirement years. Knowing what type of plan and which one is right for you can be daunting. With that in mind, here are some key points to help distinguish the differences between the following plans. All dollar amounts are quoted for 2019 contribution limits.
SEP IRA:
• Establish Plan by- Tax filing deadline Including extensions
• Ease of plan establishment- Easy
• Maximum employer contribution amounts- 25% of W-2 wages or 20% of net profits for schedule C filer, maximum contribution $56,000
• Employee deferral maximum- not allowed, only employer contributions or self-employed schedule C filer net profit formula
• Participation restrictions- May place age restriction up to age 21 and work requirement of 3 out of last 5 years and earned at least $600 in the current year
• Tax filing requirement- No separate filing requirement
• Vesting- 100% immediate vesting
• Loans- Not allowed
• Administrative costs- Low to none
• Pretax/ after tax- Only pretax allowed
• Ideal for- Small firm/business
SIMPLE IRA:
• Establish Plan by- October 1st of the current year
• Ease of plan establishment- Easy
• Maximum employer contribution- 3% match on W-2 wages/net self-employment income or 2% non-elective contribution
• Employee deferral maximum- $13,000 under age 50, $16,000 age 50 or older
• Participation restrictions- may limit participation to employees with at least $5,000 in income in any 2 preceding years and who is reasonably expected to earn $5,000 in the current year
• Tax filing requirement- No special tax reporting required
• Vesting- 100% immediate vesting on both employee and employer contributions
• Loans- Not allowed
• Administrative costs- Low to none
• Pretax/after tax- Only pretax allowed
• Ideal for- Small firm/business – cannot be over 100 eligible participants based on statute
INDIVIDUAL OR SOLO 401K:
• Establish Plan by- December 31st or business fiscal year end
• Ease of plan establishment- Moderate
• Maximum employer contribution- 25% of wages or specific formula for self- employed with a maximum total combined limit including employee deferrals $56,000 under 50 years old and $62,000 for 50 or older
• Employee deferral maximum- $19,000 under age 50, $25,000 for 50 or older
• Participation restrictions- Limited to 1 person firm or 1 person plus spouse
• Tax filing requirement- Generally a form 5500 (EZ) must be filed for plans with $250,000 or more
• Vesting- 100% immediate vesting
• Loans- Available
• Administrative Costs- Low
• Pretax/ after tax- Both pretax and after tax (Roth) allowed on deferrals
• Ideal for- 1 or 2 person (if spouse) firm/business
TRADITIONAL 401K:
• Establish Plan by- December 31st or business fiscal year end
• Ease of plan establishment- More complex
• Maximum Employer contribution- Combined employer and employee deferrals can be up to $56,000 under 50 years old and $62,000 for 50 or older. Different plan designs may be utilized to maximize these limits.
• Employee deferral maximum-$19,000 under age 50, $25,000 for 50 or older
• Restrictions- Various participation limits may be placed on eligibility and timing of participation, most flexible plan for design purposes.
• Tax filing and regulatory requirements- Generally form 5500 must be filed with few exceptions. Various annual testing requirements must be met, unless safe harbor provisions are met.
• Vesting- Employee deferrals are 100% vested immediately, may have vesting schedules for employer contributions.
• Loans- Available
• Administrative costs- Moderate to High
• Pretax/ after tax- Both pretax and after tax (Roth) allowed on deferrals
• Ideal for- Small to large firm/business
As you can see, each type of plan has pros and cons. Depending on what your goals and objectives are, one plan will hopefully meet your needs. If not, it is possible that you may also find that contributing to a Traditional IRA or ROTH IRA may make more sense for you. As IRA and ROTH IRA options are more about the individual and not an employer/self employed plan, they are not included in the breakdown.
This material is intended for informational/educational purposes only. Please contact your financial professional for more information specific to your situation
Christian Bishop CFP®, EA