What is the Best Retirement Plan for Your Small Business?

Investing
You can trust that we maintain strict editorial integrity in our writing and assessments; however, we receive compensation when you click on links to products from our partners and get approved. Here's how we make money.

By: James Shagawat

Learn more about James on NerdWallet’s Ask an Advisor

Self-employed people have several special retirement plans from which to choose, including a Simplified Employee Pension (SEP), a Keogh, a SIMPLE, or an individual 401(k). All of the plans allow you to deduct your contributions from your income, and the money grows tax deferred in retirement.

SEP-IRA

The SEP is designed for self-employed individuals and small business owners, typically with 25 employees or less.

SEPs work well for family-run businesses. All must be given the same match. Once you hire outside of the family, it begins to not work as well.

SEP is the appropriate plan option when the employer is going to fund all of the plan benefits.

The SEP is easier for an employer to setup than a qualified plan like a 401(k), because the plan documents are less complicated and there are fewer IRS reporting requirements. This translates into lower administration expenses and less time spent operating the plan.

Contributions must be fully and immediately vested in the contributions to SEPS. Vesting is when employer contributions are now fully yours.

SIMPLE

SIMPLE is an IRA used by small businesses with 100 or fewer employees.

When the employer wants to allow employees the opportunity to make additional contributions on a pretax basis, then the SIMPLE is the appropriate choice.

The SIMPLE is easier for an employer to setup than a qualified plan like a 401(k) because the plan documents are less complicated and there are fewer IRS reporting requirements.

Contributions must be fully and immediately vested in the contributions to SIMPLE.

If you have employees other than family, as the employer you are only responsible to match if the employee contributes. Contributions are less than those of a 401(k). The maximum contribution for employees in 2013 is $12,000 plus a $2,500 catch-up if you’re over 50 years old. The $12,000 is just the employee’s maximum contribution. The employer can match up to 2% of employee compensation on top of the maximum contribution. The employer must offer the plan for each eligible employee. (This includes the employer herself).

Solo 401(k)

The Best Retirement Plan if you’re Self-Employed. The solo 401(k) combines the best features of the SIMPLE and the SEP.

If you have no employees other than a spouse, you can take advantage of a retirement plan known variously as an individual 401(k) also called a solo 401(k).

You don’t have to earn as much as you do with other retirement plans to qualify for the maximum tax-deductible contribution. The solo 401(k) gives you much higher contribution limits. You can contribute up to $17,500 in 2013 as an employee, an additional $5,500 if you’re over 50. Then, your business can kick in another 20% of your self-employment income (defined as total business income minus half of your self-employment tax).

Roth Solo 401(k)

The Roth Solo 401(k) possesses the same benefits of the Solo 401(k), but with the tax benefits of Roth-type contributions.

If you want Roth tax-advantages (tax-free distributions) with a substantial contribution limit, then the Roth Solo 401(k) is for you. Also, if you were interested in a Roth IRA, but you don’t qualify because of income limits, then the Roth Solo 401(k) is an option to consider.

Ask yourself what you want to get out of the plan. Do you desire to adequately provide for rank-and file employees or favor key employees and just meet the minimum requirements for other employees? Do you want to attract, retain and motivate key employees or do you want the most administratively convenient plan? Knowing what you want will lead you down the crooked path to the perfect plan.