Although many large organizations offer retirement savings plans, it is not necessary to be a part of corporate America in order to take advantage of tax-deductible retirement plans for investing in your future.
In fact, as a self-employed small business owner or an employee of a small business, you have several options with regard to tax-advantaged saving for retirement.
Further, if you have a stand alone side-business and a full-time corporate job you can double-dip by taking advantage of small business designated retirement plans along with your company’s 401K plan.
Solo or Individual 401(k) Plans
A 401(k) plan is a type of retirement savings plan that is funded by employee contributions, and often with matching contributions from an employer. 401(k) retirement plans essentially allow workers to save for their retirement, while also deferring current income taxes on that saved money as well as the earnings it produces until the time of withdrawal.
While 401(k) plans are often thought of as being offered at large companies, Individual or Solo 401(k) plans are available to self-employed individuals and small businesses. They are basically like your traditional 401(k) plan but cover a business owner with no employees, and limited to owner and his or her spouse.
So in essence the business owner in a Solo 401(k) plan is both the employee and employer.
Most contributions to a 401(k) plan are made on a pre-tax basis. For these pre-tax contributions, employees do not have to pay federal income tax on the amount of the income that they defer into their 401(k) retirement account.
One of the biggest benefits to an Individual or One-Participant 401(k) plan is that contributions are allowed to be made at the same income levels as those who are participating in large company 401(k) plans.
This can help those who are self-employed or employees of small businesses to maximize their contributions for retirement and to also take advantage of the same tax deductions as large corporations get.
The individual pre-tax contribution limit for 401(k) plans are adjusted by the IRS annually and shown in the table below.
The acronym SIMPLE IRA stands for Savings Incentive Match Plan for Employees. With SIMPLE IRA retirement plans, employees as well as their employers may make tax deductible contributions into traditional IRA accounts that are set up for employees – including self-employed individuals – subject to certain annual limits shown in the table below.
SIMPLE IRAs are ideally suited as a start-up retirement savings plan for small employers who do not currently sponsor a 401K retirement plan. This means they are popular with self-employed workers and employees of small businesses.
The main advantage of a Simple IRA to other tax advantaged retirement plans is the much lower administration and overhead costs. They can be opened and managed via most large brokerages.
|Year||Contribution Limit (Age under 50)||Contribution Limit (Over 50)|
The maximum contribution is the smaller of the above statutory limits or 3% of each employee’s compensation.
In order to establish a SIMPLE IRA, the business must have 100 or fewer employees and it also cannot have any other type of retirement plan in place.
A SEP IRA is a Simplified Employee Pension Plan. Under a SEP IRA , an employer makes contributions into a traditional IRA account that is set up for the employees of the small business, subject to certain limits and conditions. This also holds true for self-employed individuals.
|SEP Employer Contribution Limit||$66,000 or 25% of compensation||$61,000 or 25% of compensation||$58,000 or 25% of compensation||$57,000 or 25% of compensation|
|SEP Minimum compensation||$750||$650||$650||$600|
|SEP Annual Compensation Limit||$330,000||$305,000||$290,000||$285,000|
|SEP Contribution Deadline||April 15, 2024||April 17, 2023||April 15, 2022||May 17, 2021|
A SEP IRA retirement plan can be established by small businesses as well as by self-employed individuals. Similar to having a SIMPLE IRA, with a SEP IRA plan the business or self-employed person must not have any other type of retirement plan currently in place.
You are eligible to contribute to a SEP IRA even if you are already covered by a retirement plan at your full-time job or have retirement plans from other employment sources. The SEP IRA limit is independent of the 401K or IRA contribution limits as discussed here.
The term ESOP stands for Employee Ownership Plan. An ESOP is a type of employee benefit plan that makes the employees of a business owners of stock in that company. Several features make an ESOP unique as compared to other types of employee benefit plans.
First, only an ESOP is required by law to invest primarily in the securities of the sponsoring employer. In addition, an ESOP plan is unique among qualified employee benefit plans in its ability to borrow money.
In an ESOP plan, a company essentially sets up a trust fund into which it then contributes new shares of its own stock or cash to buy existing shares of stock. Alternatively, the ESOP plan can borrow money to purchase new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan.
No matter how the ESOP plan acquires the shares of stock, the company contributions into the established trust will be tax-deductible within certain limits.
When employees who participate in an ESOP plan leave their place of employment, they can receive their shares of stock, which the company then must buy back from them at the current fair market value.
To open one of the above plans you need to go through a broker (see this page for a list of low-cost IRA brokers)
2 thoughts on “Small Business Retirement Plans – 401k, SEP IRA, Simple IRA and ESOP plans – 2022-2023 Contribution Limits”
If you’re self-employed, you might be able to do several of these plans in steps. Start with an IRA (traditional or Roth) when the business is new and growing. You don’t need the cost and administrative headaches of the more complex plans at this point.
As the business grows and seems more established, go for the SEP or SIMPLE. At this point presumably you have the predictability of funding, as well as the resources to pay some one to administer the plan.
As you move closer to retirement, go with the 401k and maximize both the contributions and the company match. That will enable you build up money at the last minute, should that become necessary. $22,000 over age 50–plus a company match–is a lot of money accumulating in a short space of time.
If you work in a small business, and your 401k is in the hands of the proprietor, be very careful. My employer is very irresponsible in handling contributions, investing them on time, etc. I suggest you max out your individual IRA where you have more and safer options before you entrust any of your retirement funds to your boss who may or may not handle them well.