Choosing a Retirement Plan for Your Small Business

Payroll Deduction IRAs

Even if an employer doesn’t want to adopt a retirement plan, the employer can allow its employees to contribute to an IRA through payroll deductions, providing a simple and direct way for employees to save. In this type of arrangement, the employee always makes the decisions about whether, when, and how much to contribute to the IRA (up to $6,000 for 2020 and for 2021, and $7,000 for 2020 and for 2021 if age 50 or older, increasing thereafter).

Some individuals eligible to contribute to an IRA wait until the end of the year to set aside the money and then find that they don’t have sufficient funds to do so. Payroll deductions allow employees to plan and save smaller amounts each pay period. Payroll deduction contributions are tax-deductible by the employee, to the same extent as other IRA contributions.

Simplified Employee Pensions (SEPs)

A SEP plan allows employers to set up SEP IRAs for themselves and each of their employees. Employers generally must contribute a uniform percentage of pay for each employee, although they do not have to make contributions every year. Employer contributions are limited to the lesser of 25 percent of pay or $57,000 for 2020 and $58,000 for 2021. (Note: the dollar amount is indexed for inflation and may increase.) Most employers, including those who are self-employed, can establish a SEP.

SEPs have low start-up and operating costs and can be established using a two-page form (Form 5305-SEP). And you can decide how much to put into a SEP each year – offering you some flexibility when business conditions vary.

SIMPLE IRA Plans

A SIMPLE IRA plan is a savings option for employers with 100 or fewer employees.

This plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. Under SIMPLE IRA plans, employees can set aside up to $13,500 in 2020 and in 2021 ($16,500 in 2020 and in 2021 if age 50 or older) by payroll deduction (subject to cost-of-living adjustments in later years). Employers must either match employee contributions dollar for dollar – up to 3 percent of an employee’s compensation – or make a fixed contribution of 2 percent of compensation for all eligible employees, even if the employees choose not to contribute.

SIMPLE IRA plans are easy to set up. You fill out a short form to establish a plan and ensure that SIMPLE IRAs (to hold contributions made under the SIMPLE IRA plan) are established for each employee.

One-Participant 401(k)

A one-participant 401(k) plan is sometimes called a:

• Solo 401(k)
• Solo-k
• Uni-k
• One-participant k

The one-participant 401(k) plan isn't a new type of 401(k) plan. It's a traditional 401(k) plan covering a business owner with no employees, or that person and his

The business owner is both the employer and the employee.  Contributions can be made to the plan in both capacities. The owner can contribute both:

• Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit: $19,500 in 2021, or $26,000 in 2021 if age 50 or over; plus
• Employer nonelective contributions up to: 25% of compensation as defined by the plan, or a special computation to figure the maximum amount you can make for yourself.

Contribution limits in a one-participant 401(k) plan

The business owner wears two hats in a 401(k) plan: employee and employer. Contributions can be made to the plan in both capacities. The owner can contribute both:

• Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit: $19,500 in 2020 and 2021, or $26,000 in 2020and 2021 if age 50 or over; plus
• Employer nonelective contributions up to: 25% of compensation as defined by the plan, or for self-employed individuals, see discussion below.

Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $57,000 (for 2020; $58,000 for 2021).

A business owner who is also employed by a second company and participating in its 401(k) plan should bear in mind that his limits on elective deferrals are by person, not by plan. He must consider the limit for all elective deferrals he makes during a year.