Small Business Retirement Plans

Small business owners and self employed individuals typically select from four self employed retirement plans; the Individual 401k, SEP IRA, Defined Benefit Plan or Simple IRA.

When selecting from these self employed retirement plans the primary factors that determine which plan is appropriate are your age, annual income,  your desired annual contribution and/or if you would like the option of a loan. Small business retirement plans benefit a small business owner differently depending on these factors.

SEP IRA

Features:

• In 2009 there is a $49,000 maximum contribution.
   
• Easy to set up and minimal administrative responsibilities.

Disadvantages:

• An Individual 401k may provide a larger contribution compared to a SEP IRA at the same income level.
   
• For those age 50+ there isn't an additional catch-up provision like there is with the Individual 401k.
   
• Loans are not permitted

What are the advantages of a SEP IRA?

A SEP IRA has a maximum contribution limit of $49,000 in 2009. The annual contribution into a SEP IRA is based on a percentage of W-2 wages if you are incorporated or personal income if you are a sole proprietorship.

S or C corporation or a LLC taxed as a corporation

• For incorporated businesses up to 25% of W-2 wages can be contributed into a SEP IRA.

Sole proprietorship, partnership or a LLC taxed as a sole proprietorship

• Annual contributions up to 20% of your net adjusted self employment income (or net adjusted business profits) can be contributed into a SEP IRA.

The SEP IRA is a great choice for self employed business owners who would like to contribute up to 25% of their W-2 wages or 20% of net self employment income. A SEP IRA has broad appeal due to its high maximum contribution limits and its ease to set up and maintain.

Individual 401k

Features:

• In 2009 there is a $49,000 maximum contribution ($54,500 if age 50+ due to a "catch-up" provision).
   
• Tax free loans are permitted with an Individual 401k plan. Loans are permitted up to 1/2 of the total value of the Individual 401k up to a maximum of $50,000.
   
• Roth 401k  - There is an option to make Roth 401k contributions with the salary deferral portion of the Individual 401k.  Contributions into an Individual Roth 401k  are not tax deductible, but withdrawals are tax free after age 59 ½.

Disadvantages:

• Potentially greater administrative responsibilities and administrative fees compared to other self employed retirement plans.

What are the advantages of the Individual 401k?

The most popular self employed retirement plans are the SEP IRA and Individual 401k. Both plans have high contribution limits and have completely discretionary annual funding requirements. In 2009 a SEP IRA has a maximum contribution limit of $49,000 and an Individual 401k has a contribution limit of $49,000 ($54,500 if age 50+).

A SEP IRA is easier to setup and has less administrative costs than an Individual 401k, however an Individual 401k may allow a greater contribution at the same income level due to the way the contribution is calculated.

After tax Roth contributions can be made into an Individual 401k.  Roth 401k contributions are not tax deductible, but are received tax free when withdrawn after age 59 ½.  SEP IRA contributions can only be made pre-tax and does not have a Roth option.

Another important distinction between these self employed retirement plans is an Individual 401k has a loan provision.  IRS rules do not allow loans with a SEP IRA.  Individual 401k loans are permitted up to 50% of the total 401k value with a $50,000 maximum.

Defined Benefit Plans

Features:

• Depending on the age and income of the business owner, annual contributions can exceed $100,000 or more.
   
• Loans may be permitted, however this may increase annual funding requirements.

Disadvantages:

• More expensive to set up and to maintain.
   
• Rigid annual funding requirements.

What are the advantages of a Defined Benefit Plan?

Do you want to contribute more than the contribution limits allowed by the SEP IRA or Individual 401k? Then consider a Defined Benefit Plan.

The Defined Benefit Plan is appropriate for those age 45 or older who wish to make tax deductible contributions in excess of the maximum limits of the Individual 401k or SEP IRA. Defined Benefit Plans offer substantial tax deductible retirement contributions and significant future retirement income.  Depending on your age and income the annual contribution to a Defined Benefit Plan can exceed $100,000.

Defined Benefit Plans have greater administrative fees and more rigid annual funding requirements, but may be ideal for business owners who wish to shelter the largest percentage of their income and/or who want to make the largest retirement plan contribution permitted by IRS rules.

Simple IRA

Features:

• A Simple IRA is easy to set up and has low administrative responsibilities.
   
• Self employed individuals can elect to defer up to 100% of their income up to a maximum of $11,500 for the 2009 year or $14,000 if age 50+. In addition there is a maximum 3% employer contribution.

Disadvantages:

• Relatively low maximum annual contribution limits. 
   
• Loans are not permitted

What are the advantages of a Simple IRA?

Self employed business owners that have a Simple IRA are able to contribute up to 100% of their income up to the maximum contribution limits of $11,500 or $14,000 if age 50+. As a result, significant contributions can be made into a Simple IRA even at lower income levels. A good candidate for this plan doesn't mind the relatively low maximum contribution limits. Self employed individuals who would like to contribute in excess of the limits of a Simple IRA should consider an Individual 401k since it may allow a larger contribution.

Learn more about these Self Employed Retirement Plans.

Disclosures:

*  The information on this page is for informational purposes only and does not constitute, and should not be construed as, professional, legal or tax advice. To determine your individual tax situation and specific needs, please consult a professional tax advisor.

* Information contained in these sections merely highlight some benefits. There are risks involved with all investments that could include tax penalties and risk/loss of principal.