Q: I want to open a retirement plan for myself and my small business. I'm self-employed now, but may soon have employees. What should I look at?
Terrence, Arlington VA
A: There are several major types of defined-contribution retirement plans businesses can set up. Below is a brief introduction to them:
N.B. A very good description of these can be found in IRS Publication 590, Retirement Plans for Small Businesses
1. 401(k) Plans. In this arrangement, there are two contributions--the employer contribution (limited to 25% of employee compensation, 20% in the case of a sole proprietor), and the employee's "elective deferral" of salary (the lesser of $15,500 in 2008 or 100% of compensation). Business people on their own can make both contributions, subject to certain limits.
The employee deferral can be done either pre-tax (Traditional 401(k)), or after-tax (a "Roth 401(k)" option, in which the money is tax-free in retirement.
All 401(k) contributions combined cannot exceed the lesser of $46,000 or 100% of compensation for 2008. Above and beyond these limits, a taxpayer over age 50 may contribute an additional $5000 in "catch-up" contributions.
A similar type of plan for non-profits and teachers exists, the 403(b). These are largely being replaced by 401(k) plans, though.
A variant on the theme is the government deferred compensation 457 plan for state and local government employees. Here, there are no employer contributions, and the elective deferral limit applies to the employee.
2. SEP-IRAs. These have been around longer than any other option, and are very popular with the self-employed. The rule is simple--a taxpayer can contribute up to 20% of compensation from self-employment (or 25% of salary paid). The money is deductible from income (though not SECA) tax for the self-employed.
Basically, think a 401(k) minus the elective deferral and you get the idea. The overall $46,000 limit applies.
3. SIMPLE IRAs. These are easy to administer, low-contribution 401(k) plans. The elective deferral limit is $10,500 ($13,000 for over-50). The employer match must be either:
a. 3% matching contribution, or
b. 2% non-elective contribution
To me, it doesn't make a whole lot of sense to open a SIMPLE IRA if you are a small business. You may as well open a 401(k) and get the full benefits.
Comments