Comparing Your Retirement Plan Options
Retirement plan contributions made for yourself and your workers are generally tax deductible as a business expense. Offering one of these retirement plans could help you shelter more of your income from taxes and build wealth outside of your business. It might also be an effective way to reward and help retain valuable employees.
401(k) plan. Some 401(k) plans are becoming easier and less expensive for small firms to set up and maintain. Owners can often make larger contributions for themselves (as employee and employer) in exchange for making contributions or “matches” for employees.
The maximum employee contribution is $18,000 ($24,000 for those 50 and older) in 2016. The required match is a minimum 100% of each participant’s first 3% of salary plus 50% of the next 2% of salary, or a non-elective contribution equal to 3% of salary for all eligible employees. A match or profit-sharing contribution up to 100% of an employee’s compensation is allowed, up to a $53,000 cap (from both sources, not including catch-ups) in 2016.
With a solo 401(k), a business owner with no employees can make a contribution up to the $18,000 employee limit ($24,000 for those 50 and older). As employer, the business can contribute an additional 20% of the owner’s compensation (25% if incorporated), up to the $53,000 cap.
SEP IRA (simplified employee pension). A SEP IRA may be a good choice for self-employed individuals, business owners who want to maximize contributions, and small businesses with mostly lower-paid employees. The same percentage of salary (up to 25% of compensation or $53,000) must be contributed to each eligible employee’s SEP IRA, including the owner’s. The business is not required to contribute every year. Self-employed individuals can contribute 20% of net earnings, up to $53,000 in 2016.
SIMPLE IRA. Companies with 100 or fewer employees may use a SIMPLE IRA salary-reduction plan, which requires little or no paperwork. The maximum employee contribution in 2016 is $12,500 ($15,500 for those 50 and older). The required match is 100% of the first 3% of participant contributions or 2% of all eligible employee salaries.
Distributions from employer-sponsored retirement plans are taxed as ordinary income. Withdrawals prior to age 59½ may be subject to a 10% federal income tax penalty. Early withdrawals from a SIMPLE IRA (prior to age 59½) during the first two years of participation may be subject to a 25% penalty; 10% thereafter.