A retirement plan is a great way for business owners and self-employed individuals to build wealth for retirement. Retirement plans are also a useful method to attract and retain better employees. Most plans are easy to set up and operate and offer significant tax advantages. How so?

• Contributions that your business makes to your account and your employees’ accounts are generally deductible as a business expense.
• Pre-tax contributions that you make to your account as an employee reduce your current income taxes.
• Roth contributions may be an option with some plans.
• Earnings grow tax-deferred.

Plus, you generally can contribute more to a business retirement plan than you can to a personal IRA.

Here are a few types of plans to consider.

SEP IRA

• Easy to set up and operate.
• High contribution limits.
• Funded by employer contributions only.
• Employers do not have to contribute every year.

A Simplified Employee Pension plan, also known as a SEP IRA, is one of the easiest retirement plans to set up and run. Administration is minimal, and annual government filings are not required.

With this type of plan, separate IRA accounts are set up for you and your eligible employees. The accounts are funded solely by the employer, who contributes the same percentage of compensation for each eligible employee.

Contributions can range from 0% to 25% of compensation and are capped at $66,000 per employee in 2023. The percentage can vary from year to year, which gives you the flexibility to adjust contributions every year or even skip making them altogether.

When deciding whether a SEP IRA is right for you, keep in mind that your company must contribute the same percentage of compensation for every eligible employee. So if your goal is to max out your own account by contributing 25% of your compensation, your company must also contribute 25% of each employee’s compensation to their accounts.

2023 Contribution limit for a SEP IRA

EMPLOYER: 0% to 25% of each eligible employee’s compensation*, up to $66,000.

SIMPLE IRA

• Easy to set up and operate.
• Your employees can contribute.
• Employer contributions are required.
• Available only to self-employed individuals or businesses with 100 or fewer employees that do not have another retirement plan.

If the idea of an easy to manage retirement plan appeals to you, but you want your employees to be able to contribute to their own accounts, take a look at the SIMPLE IRA.

The SIMPLE IRA allows all eligible employees, including you, to contribute up to the lesser of $15,500 or 100% of their compensation in 2023. Individuals who are age 50 or older can contribute up to $19,000 per year as a catch-up contribution.

Employer contributions are required every year. Your company can either match each employee’s contributions dollar-for-dollar, up to 3% of their compensation, or it can contribute 2% of each eligible employee’s compensation.

2023 Contribution limit for SIMPLE IRA or SIMPLE 401(k)

SIMPLE IRAs do not require nondiscrimination testing and annual government filings, making them a good choice for small businesses that want to keep retirement plan administration to a minimum.

EMPLOYEE: Up to $15,500 ($19,000 if age 50 or older).

EMPLOYER: The employer must either match employee contributions, up to 3% of their compensation, or contribute 2% of compensation for all eligible employees.

401(k) Plan

• Greater flexibility in plan design.
• High contribution limits.
• Allows larger employee contributions than a SIMPLE IRA plan.

401(k) plans typically offer features that you cannot get with an IRA plan. For example, certain 401(k) plans can be set up so that employer contributions vest over time, which can help you retain employees. Participant loans may be an option for employees. And employees can generally contribute more to a 401(k) plan than to other types of plans.

In most types of 401(k) plans, eligible employees can contribute up to $22,500 of their compensation in 2023. And if they are age 50 or older, they can generally contribute up to an additional $7,500 as a catch-up contribution.

Employers can also generally contribute to their employees’ accounts by matching employee contributions or by making contributions for all eligible employees.

Among the various types of 401(k) plans, the traditional 401(k) plan offers employers the most flexibility in plan design, including the ability to have employer contributions vest over time. Annual testing is required to ensure that the plan does not discriminate in favor of highly compensated employees.

You can eliminate the need for nondiscrimination testing by choosing a safe harbor 401(k) plan. This type of plan avoids testing by requiring the company to make a certain level of employer contributions each year that must be immediately 100% vested.

Another type of plan, the SIMPLE 401(k), also eliminates the need for nondiscrimination testing. Available to businesses with 100 or fewer employees that do not have another retirement plan, the SIMPLE 401(k) combines some of the ease of a SIMPLE IRA with some features of a 401(k) plan, such as participant loans and hardship withdrawals. The contribution limits for employees and employers are the same as for the SIMPLE IRA.

Individual or Solo 401(k) Plan

• High contribution limits.
• Available only to self-employed individuals and owner-only businesses.
• Generally easier to manage than a traditional 401(k) plan with employees.

An individual 401(k) plan, also known as a solo 401(k), is an option for self-employed individuals and owners of businesses without employees, other than a spouse.

Like other types of 401(k) plans, individual 401(k) plans are funded by both employee and employer contributions. As the employee, you can contribute up to $22,500 of your compensation, or up to $30,000 if you are age 50 or older. As the employer, your business can contribute up to 25% of your compensation. The total contributions to your account for 2023 cannot exceed $66,000, or $73,500 if you are age 50 or older and make catch-up contributions.

Individual 401(k) plans are generally easier to manage than traditional 401(k) plans that cover businesses with employees. Nondiscrimination testing is not required as long as you do not have employees, and you generally do not need to file an annual report with the IRS until assets in the plan exceed $250,000.

2023 Contribution limit for 401(k)

EMPLOYEE: Up to $22,500 ($30,000 if age 50 or older).

EMPLOYER: Employers can generally contribute up to 25% of compensation1.

TOTAL CONTRIBUTIONS: May not exceed the lesser of the employee’s compensation or $66,000 ($73,500 if age 50 or older).

PLEASE NOTE:

*If you are self-employed, your compensation is your net earnings from self-employment, which is calculated using a special computation.

With a traditional retirement account, pre-tax contributions and earnings are taxed as ordinary income when withdrawn from the account. Withdrawals before age 59½ are also generally subject to a 10% early withdrawal tax penalty (25% if the withdrawal is made in the first two years of participating in a SIMPLE IRA plan) unless an exception to the penalty applies.

With a Roth retirement account, withdrawals are tax-free and penalty-free if made after age 59½ and after the account has been open for five years.

The max compensation that may be considered is $330k for 2023.

To learn more about your options and help you determine if one of these would be a good fit for you please contact Copper Leaf Financial at 802.878.2731 or click here to schedule a strategy session.

This article was originally published in the May/June 2022 issue of Eye on Money and updated in August 2023.

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