For small business owners, the benefits of launching a retirement plan are pretty clear and enticing. Not only do they help in building enough money to one day retire, they also provide an important benefit that allows them to better attract and retain top employees and, perhaps most-importantly, to save each year on personal and business taxes.
But when it comes to taking the first step of researching and actually choosing a plan that best fits their business, things can quickly become confusing and, well, paralyzing. Maybe it’s because of the number of providers in today’s market or the intimidating names of products that are mostly comprised of clunky and ambiguous acronyms and numbers such as SEPs, IRAs and 401(k)s. At first blush, it’s enough to make any already-stressed business owner feel overwhelmed.
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And while there are several types of plans to choose from, in the end, three stand out as good-fits for small business with less than 25 employees. They are: 401(k) plans, SEP IRAs and SIMPLE IRAs.
To help simplify the process of choosing the right plan, following are some plain English descriptions of each that include a side-by-side look at how they compare and contrast:
The traditional 401(k) is probably the most widely known retirement product on the market and is generally defined as one that enables a business owner and his employees to make consistent, tax-deferred contributions to during the length of their careers.
In most instances, a 401(k) provides small businesses with the most flexibility. 401(k)s not only offer higher contribution limits than other plan options, but also offer more choices in design to manage business costs, employer contributions, taxes, and enable penalty-free access to funds via a loan if an emergency arises before reaching retirement age (59 ½). 401(k) plans also allow for “catch-up” contributions after reaching the age of 50. In 2010, employees can contribute up to $16,500 if under 50 years of age, $22,000 if over.
For small businesses and employees that may fear higher tax rates down the road, the Roth 401(k) enables participants to have their contributions taxed up-front, but withdrawals after reaching retirement are tax-free, earnings and all. This can be a big help in managing your tax situation and money over time.
A SEP IRA
Simplified Employee Pensions, more commonly referred to as SEPs, are perhaps the most-popular retirement plans for the self-employed and offer a contribution limit that’s similar to a 401(k). One of the most important things to understand about SEPs is that 100 percent of the contributions made are by the employer (no employee contributions allowed) and these dollars are immediately vested for the employee. There is no Roth option or catch-up options for those over 50 years of age like there are with a 401(k).
The Simple IRA
The SIMPLE IRA’s name is a bit misleading (it actually stands for Savings Incentive Match Plan for Employees). While both employer and employee can contribute to the plan, the employer must match and matching is vested immediately. Also, the contribution limit is set at $11,500 for 2010, a full $5,000 less than a 401(k). The catch-up for those over 50 is also less at $2,500 versus $5,500 for a 401(k).
A summary of important differences are here below:
If the current economy has taught small business owners anything it’s the importance of having a savings plan. And while they require a fair amount of research and shopping by business owners at the front end, they provide valuable long-term benefits that help ensure a more secure future for business owners and their employees.
Stuart Robertson is general manager and principal of ShareBuilder Advisors, LLC which operates www.ShareBuilder401k.com. ShareBuilder Advisors, LLC is a subsidiary of ING Bank, fsb.