From SEP to 401(k): Comparing Retirement Plans for Small Businesses

Discover the best retirement plan for your small business. Explore the pros and cons of SEP, SIMPLE, and 401(k) options to help secure financial futures and retain top talent.

• Pros:
  • Simplicity: SEP IRAs are easy to establish and maintain, making them ideal for small businesses with few or no employees.
  • High contribution limits: Employers can contribute up to 25% of an employee’s compensation, up to $69,000 in 2024.
  • Flexibility: Contributions are discretionary, allowing businesses to adjust contributions based on their financial situation.
  • Employer contributions only: Employees cannot contribute to a SEP IRA, which may be a drawback for businesses looking to offer employee-funded retirement benefits.
  • Mandatory contributions: If the employer decides to contribute for themselves, they must contribute the same percentage of compensation for all eligible employees.
  • Vesting options: Employees are always 100% vested in their accounts. This plan type does not incentivize employee retention.

  SIMPLE IRA (Savings Incentive Match Plan for Employees)

  • Pros:
    • Easy administration: Like SEP IRAs, SIMPLE IRAs have minimal administrative requirements, making them suitable for small businesses.
    • Employee contributions: Employees can contribute to their SIMPLE IRAs through pre-tax and Roth salary deferrals, fostering a sense of ownership and responsibility for their retirement savings. Maximum employee contributions are $16,000 ($17,600, if the plan is eligible*) for 2024. Catch-up contributions are allowed for employees 50 years of age or older in the amount of $3,500 ($3,850 if eligible*).
    • Matching contributions: Employers are required to match employee contributions up to 3% (4% if eligible) of compensation, which can serve as a valuable employee incentive.
    • Lower contribution limits: Compared to other retirement plans, SIMPLE IRAs have lower contribution limits, which may not be sufficient for businesses with higher earning employees.
    • Limited flexibility: Employers must make either matching contributions or non-elective contributions of 2% (3% if eligible*) of employee compensation, which may not align with varying business performance.
    • Vesting options: Employees are always 100% vested in their accounts so this plan type does not incentivize employee retention.

    401(k) plans

    • Pros:
      • High contribution limits: 401(k) plans offer higher contribution limits than SIMPLE IRAs, allowing employees to save more for retirement.
      • Employee deferrals: Employees can contribute to their 401(k) accounts through pre-tax, Roth, and post-tax salary deferrals. Maximum employee contributions for 2024 are $23,000 with catch-up contributions of $7,500 for those employees aged 50 and over.
      • Vesting options: Employers have the flexibility to choose vesting schedules, allowing them to incentivize employee retention. The two most common vesting schedules are 2-6 graded, where an employee vests 0% in year one but then 20% each subsequent year or three-year cliff, where an employee vests 0% in years one and two but then 100% in year three.
      • Administration complexity: Compared to SEP and SIMPLE IRAs, 401(k) plans involve more administrative responsibilities and may incur higher costs.
      • Compliance requirements: 401(k) plans are subject to strict compliance regulations, requiring annual testing to ensure the plan does not excessively favor highly compensated employees.
      • Employer contributions: While optional, offering employer matching contributions can be costly for businesses, especially during economic downturns.

      Choosing the right retirement plan for your small business requires careful consideration of various factors, including business size, stability of cash flow, employee demographics, and financial goals. While each retirement plan offers its own set of advantages and disadvantages, the key is to select a plan that aligns with your business objectives and provides valuable benefits to both employers and employees alike. Consulting with a financial advisor or retirement plan specialist can help navigate the complexities and make an informed decision tailored to your unique business needs.