If a 401k plan sounds too administratively taxing, you do have other IRS-approved options. Businesses with fewer than 100 employees can offer Individual Retirement Accounts (IRAs) instead. IRAs are free from the complexity and costly testing requirements of traditional 401k plans, but do provide similar pre-tax benefits. IRAs require little to no administration and cost less to start up than 401k plans, but have lower plan limits, fewer investment choices, and tighter restrictions.
A Simplified Employee Pension (SEP) IRA is best for very small companies (5 to 20 employees) or self-employed entrepreneurs. The deadline for establishing a SEP-IRA is tax day – far later than other plans. Only employers can contribute to SEP-IRAs established after December 31, 1996; these tax-deductible contributions can vary from 0% to 25% of salary. While you're not required to contribute every year, you must contribute the same percentage to all eligible employees.
Another version of the IRA is the Savings Incentive Matching Plan for Employees (SIMPLE) IRA. These plans offer a flexible, easy-to-administer solution for businesses with 100 or fewer employees that have no other retirement plan. Employees who currently earn at least $5,000 and previously earned $5,000 in any two prior years are eligible to participate.
SIMPLE-IRAs are funded by employer contributions and optional employee contributions. You must provide either a fixed 2% contribution of employee compensation to all eligible staffers or match up to 3% of employee compensation up to $10,000. If business is slow, you can reduce the amount you match for any two years in a five-year span. All matching funds are immediately 100% vested.
SIMPLE-IRAs feature lower plan limits than traditional 401k plans ($10,000 maximum in 2006; additional $2,500 catch-up for employees over 50) and must be set up between January 1 and October 1.
Reviewing 401k & Other Retirement Plans
To get a quick overview of plan limits, key features, and drawbacks to traditional 401k, IRA, and other retirement plans, read our Employee Retirement Plans Highlights chart.
Another cost-effective alternative to traditional 401k plans is a SIMPLE 401k plan. Small businesses with less than 100 employees and no other retirement plans are eligible, and can offer the plan to all employees 21 years and older that were employed for a calendar year. They don’t require discrimination testing, and administration is, well, simple.
SIMPLE 401k plans require you to match employee contributions up to 3% of salary (max of $6,000) or make a flat contribution of 2% of salary to employees. You must provide matching to all eligible employees and participants are 100% vested. The limits of SIMPLE 401k plans are considerably lower than traditional 401k plans – $10,000 in 2006 with a $2,500 catch-up for employees over 50. Also, you can’t stop contributions even when business is slow.
Sole proprietors with no employees other than a spouse may want to check out the solo 401k. It’s easy to administer and inexpensive, and the benefits are similar to conventional 401k plans. Since you’re the only employee, there’s no concern of the plan being top heavy. The solo 401k features very high limits but can only cover you and your spouse – you can no longer contribute once you add any non-spousal employees. You can contribute up to $44,000 – $15,000 from salary plus an additional profit share amount up to $29,000. If you're over 50 years of age, you can contribute an additional $5,000 per year.
Businesses can also offer profit sharing plans such as the KEOGH for employees. The fees are similar to the 401k and they provide the largest annual limits of any available plan. However, it is a very expensive option, best for very small companies with 10 to 15 employees, all of whom are highly compensated.
