Rewarding top employees and retaining new hires is a challenge for all businesses in a time of rising wages and inflation. Small, privately held businesses face the additional challenge of limited resources and the inability to offer compensation tied to publicly traded stock (such as restricted stock units or options). Employees of such firms might earn a similar salary but find their total compensation is lower, fomenting dissatisfaction. Retirement plans are key benefit that can contribute to solving this problem and offer tax advantages to both the employer and employee. For the sake of argument, we will assume that you are not your only employee and therefore Solo 401(k) plans and SEP IRAs are not ideal. While it's true that a business owner with employees can have a SEP, the requirement to contribute to the same for employees that the employer contributes for themselves can be burdensome. With that in mind, consider these options as a small business owner seeking to create a workplace retirement plan:
- SIMPLE IRA: A SIMPLE is a great choice and often my first recommendation for employers who are new to offering retirement plans. While you can't have more than 100 employees, SIMPLE IRAs offer a great balance of low cost, ease of maintenance, and relatively high contribution limits. Employers are also able to offer a 3% match or 2% baseline contribution that is tax deductible to the business. Offering the match incentivizes employees to save at least 3% of their pay while a 2% employer contribution regardless of employee contribution can be a way to help provide a least some retirement savings to low-earning employees who feel unable to save on their own. For 2023 employees (including the business owner in their capacity as a W2 employee) can contribute $15,500 plus a catch-up of $3,500 if they are 50 or over. While not equal to a 401(k) (401(k) savings are limited to $22,500 (under 50) and $30,000 (50+)) it is in the same ballpark and it's a huge upgrade from $0 which is the starting point for many employers who feel unable to implement a 401(k). The biggest advantage of the SIMPLE beyond ease of set up is cost. Many financial institutions offer SIMPLE IRA accounts that have minimal management fees or overhead, instead, they are compensated by placing the clients in mutual funds that charge internal fees and potentially a "sales load." This does create a drag on performance due to fees but it does allow for a plan to start from $0 and incur no initial costs until contributions arrive. SIMPLE IRAs do not have the requirements to hire a recordkeeper, form (or hire an outside firm to provide) an investment committee or perform non-discrimination testing, which are costly elements of 401(k) plans.
- I just made 401(k) plans sound pretty bad, didn't I? However, there are many compelling reasons to choose a 401(k) instead. The most obvious advantage is higher contribution limits which will keep high earners and the ownership group happy. More investment options and the ability to purchase very inexpensive share classes are another. 401(k)s can also grow with your company even when you exceed 100 employees. Additionally, while recent changes in the tax code allow Roth SIMPLE IRAs, many providers have yet to integrate this option, while Roth 401(k)s are offered widely and well understood. Almost all of the compliance and operations tasks associated with a 401(k) can be automated by hiring outside service providers, but these aren't free. Excepting employer contributions, I would expect a 401(k) plan to cost around $10,000 per year to operate for a business with between 50-100 employees. Since some fees are charged on a per employee basis, the plan will get more expensive as you grow. You can charge all these fees to the plan, but your employees might grumble. Fortunately, the IRS offers a tax credit for small businesses to encourage them to provide a 401(k). With respect to 401(k) costs I would caution employers to consider them in proportion to other expenses such as wages, rent, and insurance. There is tendency to consider the 401(k) in a vacuum and balk at the cost without considering them in relation to the cost of, for example, hiring and training new staff if dissatisfied employees depart.
- 401(k)s offer great flexibility and scaleability. An employer can add an ESOP or profit sharing plan while a SIMPLE IRA cannot support these generous options.
Ultimately, for an employer with a small team with few if any earners in the six figures, a SIMPLE is a great choice that should leave almost everyone satisfied. However, if your firm is already closing in on 100 employees with some high earners, a 401(k) is a better long term solution. Consider also your personal savings goals. As a business owner, do you want to be able to sock away up to $30,000 per year in a tax advantaged account? If so, offering a 401(k) to your team might be a necessary step, even if it feels like a big change.
This blog was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.