Which Retirement Plan Should Your Company Set Up?

Retirement plans are a common and popular employee benefit. At large U.S. companies, they’re almost standard. If you’re looking to attract top employees to your company, you may need to offer one.

But there’s more than one type of retirement plan in the U.S. Looking at all the different plan types can be confusing, and you might have a hard time deciding which one makes sense for your company.

401(k)s, SEP IRAs, and SIMPLE IRAs are each common with different sizes and types of companies. In this article, we’ll break down the differences so you can choose the right plan for your company and employees.

WHAT IS A 401(K) RETIREMENT PLAN?

401(k) retirement plans are the most common way of saving for retirement in the U.S. These plans are sponsored by an employer and come with tax advantages.

Employees who have access to a 401(k) plan can contribute part of their wages to their retirement accounts. The money automatically comes out of their paychecks, which makes it easy to save consistently. For the most part, each employee chooses how much they want to contribute, as long as it’s no more than the maximum limit — $22,500 in 2023.

However, there are a few situations where employees have extra limits on their 401(k) contributions. Highly Compensated Employees (HCEs) can only contribute 2% more of their paycheck to a 401(k) plan than the average employee contributes. For instance, if the average employee contributes 5% of their income to the company 401(k) plan, an HCE can contribute up to 7% of their income.

The IRS defines HCEs in a couple of ways:

• Anyone who is/was a 5% owner of the company sponsoring the plan at any time during the current plan year or prior year.
• Any employee who meets or exceeds a certain compensation threshold — $135,000 in 2022 or $150,000 in 2023 — or an employee whose compensation is in the top 20% for their company. Compensation includes regular paychecks, overtime, bonuses, commissions, and salary deferrals toward cafeteria plans.

401(k) plans, often with matching contributions from the employer, are a common employee benefit at large organizations in the U.S. Smaller employers are less likely to offer them, though.  According to research by Guideline, 90% of U.S. companies with under 100 workers do not offer their employees a 401(k) plan.

Setting up and managing a 401(k) plan takes time and investment. Many small businesses are in a poor position to make it happen.

Fortunately, there are other ways these employers can help workers save for retirement. 401(k)s are not the only kind of tax-deductible, employer-sponsored retirement plan.

WHAT IS A SEP IRA RETIREMENT PLAN?

Some employers choose to set up a SEP IRA (Simplified Employee Pension Individual Retirement Account) program instead of a 401(k) program. These programs work well for many self-employed individuals and (very) small business owners. 

As with a traditional 401(k), income in a SEP IRA grows tax-deferred until retirement. After retirement, the distributions are taxed as income. Employees own their own individual accounts. The similarities end there, though. 

One major difference is that the employer makes the contributions, not the employee. They can contribute up to 25% of an employee’s compensation or $66,000 in 2023, whichever is less. That’s a much higher maximum than the 401(k) limit! And an employer with a SEP IRA plan can skip contributions in years when business is down. 

Another difference is that SEP IRAs come with fewer start-up and operating costs than 401(k) plans. The employer doesn’t have to deal with as many management expenses.

Here’s the catch: employers have to contribute the same salary percentage for each eligible employee. If the company owner wants to stash 25% of their compensation for themself, they also have to contribute 25% of each employee’s compensation to their individual plans. That’s why these plans are best for companies with few or no employees.

WHAT IS A SIMPLE IRA RETIREMENT PLAN?

Small businesses that can’t offer 401(k) plans may still be able to offer a payroll-deducted individual retirement account (IRA) program. For example, the SIMPLE IRA (Savings Incentive Match Plan for Employees) program lets smaller employers contribute to their employees’  traditional IRAs.

SIMPLE IRA programs often come with lower administrative costs than you see with a 401(k). There is no filing requirement for the employer. As an added bonus, small employers get a tax credit to offset the costs of starting a SIMPLE IRA with auto-enrollment.

SIMPLE IRAs are available to any small business, typically those with 100 or fewer employees, as long as it doesn’t have any other retirement plan.

One thing to note: With a SIMPLE IRA plan, the employer is required to make contributions. They can choose contribute either:

• A match of up to 3% of the employee’s compensation, up to the limit
• A 2% nonelective contribution for each eligible employee, regardless of whether the employee contributes anything.

Employees are always 100% vested in all of the money in their SIMPLE IRA.

HOW TO DECIDE WHICH PLAN IS RIGHT FOR YOUR COMPANY

If your company is large (over 100 employees), it likely makes sense to set up a 401(k) plan for your employees. You may not be eligible for a SIMPLE IRA. While a SEP IRA is technically an option, the requirement that employers contribute the same salary percentage for every employee, with employees unable to make additional contributions, makes it unattractive for employees who wish to save more.

On the other hand, SEP IRAs can be a great choice for people who are self-employed, run a sole proprietorship, or only have a few employees. The start-up and operating costs of these plans are small. Employers can often contribute a much larger amount of money than they could with other plans, as long as they’re OK with contributing the same salary percentage for every employee.

If you run a small business that has between a few and a hundred employees, you may want to try a SIMPLE IRA. These plans come with employer contribution requirements but still let employees make their own contributions. With low administration costs and a tax credit to offset the costs of starting up the plan, you can set up a SIMPLE IRA with relative ease.

The most important thing is to set up some kind of retirement plan, no matter which kind you choose. Your employees likely need to save more for retirement. As an employer, you can help them prepare for their eventual old age with any of these plans.

NEED HELP SETTING UP YOUR COMPANY’S RETIREMENT PROGRAM?

LG Resources offers employee benefits consulting services to help companies save on great employee benefits packages. We can help you plan finances, qualify for tax credits, and more as you create the best employee benefits package for your team.

Reach out to us today for help setting up a 401(k), SEP IRA, or SIMPLE IRA retirement program that attracts high-caliber candidates.