Employer Retirement Plans
The creation of the Simplified Employee Pension (SEP) and the Savings Incentive Match Plan for Employees (SIMPLE) affords smaller businesses a way to offer their employees a retirement plan. The SEP and SIMPLE were designed for businesses with fewer than 100 employees and are generally less costly to administer than other retirement plans. For employees, they are easy to understand and provide a convenient way to save for retirement.
As qualified retirement plans, SEPs and SIMPLEs enjoy the same tax treatment as other plans. Contributions by employees and employers are tax-deductible or made on a pre-tax basis, and the accumulation inside the accounts grows tax-deferred. The same restrictions apply: withdrawals made prior to age 59 ½ may be subject to an early withdrawal penalty.
For businesses seeking more robust retirement savings options, 401(k), 403(b), and 412(e)(3) plans provide additional flexibility and benefits. These plans are well-suited for larger organizations or those with employees seeking higher contribution limits and additional investment features.
Simplified Employee Pension (SEP)
A SEP is easy to set up and even easier to administer. Each employee establishes their own SEP-IRA to which employer contributions are made. Although the employer is not required to contribute each year, when contributions are made they cannot exceed the lesser of 25% of covered compensation or $69,000.1
Employees manage their own SEP-IRAs, which can be invested in mutual funds, money market funds, or fixed investments. The funds are always 100% vested, so they can be accessed immediately by the employee (subject to an early withdrawal penalty). Employees with SEP-IRAs can also invest in their own traditional or Roth IRA, subject to income limitations.
For employers, the only responsibility is to make the contribution by their tax filing deadline. There is no account administration or forfeiture provision to manage.
SIMPLE Plan
In a SIMPLE Plan, employees establish their own IRA to which they can electively make tax-deductible contributions. Employees who earn at least $5,000 during any two prior years as well as the current year are eligible to participate voluntarily. The maximum contribution is $16,000 (or $19,500 for employees aged 50 and older) or 100% of their compensation, whichever is less. 2
Employee funds are 100% vested. However, in addition to the normal early withdrawal penalty of 10%, a withdrawal made within the first two years of participation incurs a 25% penalty unless an exception applies. Employers must match employee contributions up to 3% of their elective deferral or contribute 2% of all eligible employees' compensation, regardless of whether they defer. 3
There is a SIMPLE 401(k) version that allows stricter eligibility requirements but comes with increased administrative costs due to ERISA reporting rules.
401(k) Plan
A 401(k) plan is one of the most popular retirement savings options for businesses of all sizes. It allows employees to make tax-deferred or Roth contributions directly from their salaries, with annual contribution limits of $23,000 for individuals under 50 and $30,500 for those over 50 (including catch-up contributions). 4
Employers often enhance the plan’s appeal by offering matching contributions or profit-sharing options. These plans may also include loan provisions, allowing employees to borrow against their balances under certain conditions.
401(k) plans offer a wide range of investment options, including mutual funds, stocks, bonds, and target-date funds. While they provide significant flexibility, they also require more administrative oversight, including nondiscrimination testing and compliance with ERISA reporting rules.
403(b) Plan
403(b) plans are designed for employees of nonprofit organizations, schools, and government entities. Similar to 401(k) plans, they allow employees to make tax-deferred or Roth contributions from their salaries, with identical contribution limits.
One unique feature of 403(b) plans is that they are exempt from certain ERISA regulations, which can reduce administrative costs for qualifying organizations. Employers can also contribute to employee accounts through matching or discretionary contributions.
403(b) plans may offer a narrower selection of investment options than 401(k) plans, often focusing on annuities and mutual funds. However, they provide a valuable opportunity for employees in nonprofit sectors to build tax-advantaged retirement savings.
412(e)(3) Plan
A 412(e)(3) plan, also known as a fully insured defined benefit plan, is a specialized retirement plan funded exclusively with insurance contracts—typically a combination of life insurance and annuities. This type of plan is ideal for small business owners or highly compensated professionals who want to maximize their retirement contributions and secure a guaranteed income in retirement.
Contributions to a 412(e)(3) plan are determined by actuarial calculations to ensure the plan can meet its promised benefits. These contributions are tax-deductible for the employer, and the plan’s assets grow on a tax-deferred basis.
Key advantages of 412(e)(3) plans include:
- Guaranteed Benefits: Since the plan is funded with insurance contracts, retirement benefits are guaranteed, reducing investment risk.
- Higher Contribution Limits: Compared to other retirement plans, 412(e)(3) plans allow for much higher annual contributions, making them particularly attractive for those nearing retirement.
- Simplified Compliance: Because the plan is fully insured, it is exempt from some of the complex testing and funding rules that apply to other defined benefit plans.
However, these plans also come with strict requirements. Contributions must be made every year, and the insurance contracts must remain in force to maintain the plan’s tax-qualified status. Additionally, they tend to have higher administrative costs compared to other plans due to the involvement of insurance policies.
A 412(e)(3) plan is best suited for business owners with steady cash flow and a strong desire to maximize their retirement savings while securing predictable benefits.
Take the Next Step
Choosing the right retirement plan for your business and employees can be complex, but it doesn’t have to be overwhelming. Our team is here to help you explore your options to determine which plan will best suit your needs.
We can help you potentially save time and money through streamlined management and offer additional educational services to empower your employees to take full advantage of their retirement benefits.
Contact us today to get started on designing a retirement plan strategy that aligns with your goals!
For additional information on small business retirement plans:
1 Although the employer is not required to contribute each year, when contributions are made, they must be allocated to all employees over the age of 21 (including part-time employees) based on 25% of covered compensation. Source: IRS 08/20/2024.
2 The maximum contribution is $16,000 (or $19,500 for employees aged 50 and older) or 100% of their compensation, whichever is less. Source: IRS 08/20/2024
3 Employers must match employee contributions up to 3% of their elective deferral or contribute 2% of all eligible employees' compensation, regardless of whether they defer. Source: IRS 08/26/2024
4 It allows employees to make tax-deferred or Roth contributions directly from their salaries, with annual contribution limits of $23,000 for individuals under 50 and $30,500 for those over 50 (including catch-up contributions). Source: IRS 08/19/2024
