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401K, SEP, Simple, or Other? Which Retirement Account Should You Offer Your Employees?

401K, SEP, Simple, or Other? Which Retirement Account Should You Offer Your Employees?

With the recent extinction of pension plans, workplace retirement plan options have become a cornerstone of most employee benefits packages. Not only do these plans help employees save and invest for their future, but often provide tax benefits to the employee (and employer) along the way.

There are a number of different retirement plan options for employers to explore, each with their own stipulations and rules. Naturally, these rules and limitations—which range in scope from how many employees you must have to how much you must contribute each year—will dictate which plan is best for your business.

The Good Old 401K

401k plans are currently the most popular type of employer-sponsored retirement account. With these accounts, employees typically contribute pre-tax money to their account and the money grows tax-deferred until they withdraw it. It’s becoming common for plans to also offer Roth contributions (after-tax), an advantage for participants to save according to their tax situation. Employers can make the account available without any added benefit or decide to match employee contributions up to a certain amount. Or, employers can even contribute a specific percentage regardless of the employee’s contributions. Some employers offer a profit-sharing contribution as well.

Total contribution limits are as follows:

2021, $19,500 per year; $26,000 if age 50 or older

2022, $20,500 per year; $27,000 if age 50 or older

PROs

  • An employee can contribute to the plan on a tax-advantaged basis, reducing their taxable income.
  • Both employers and employees can contribute, or not. Contributions are optional for both parties.
  • Being among the most common employer-sponsored retirement plans, employees tend to be familiar and comfortable with this option.
  • Administrative expenses can be passed off to the employee if you choose to share those costs with the participants
  • High contribution limits and the option of additional profit sharing, make this plan one of the best options for maximizing savings.
  • There may be tax credit incentives for establishing a plan for the first time, talk to your tax advisor.

CONs

  • Employers must follow specific rules when setting up and administering a 401k plan, which can be time-consuming and costly. Annual tax filing is required.
  • Vesting periods may apply- the employer contributions of a non-vested employee may be at risk if the employer ceases operations or files bankruptcy.
  • Withdrawals before age 59 1/2 result in a penalty unless the account owner experiences a qualifying hardship situation.

SEP IRA

Simplified Employee Pension plans (SEPs) are another option. With an SEP IRA, employers contribute the same percentage of each employee’s income into the plan regardless of whether they make $5,000 a year or $500,000. Contributions are made to the IRA, referred to as a SEP-IRA. Whatever contribution amount the business chooses, the same amount must equally apply to all owners and employees. This means you must provide the same benefits for your employees that you provide for yourself. Unlike with the 401K, the employer solely provides contributions. Employees do not, and cannot, contribute to the plan. They do, however, retain full authority over investment decisions within the account.

Contribution limits are as follows:

2021- A maximum of $58,000 or up to 25% of business revenue—whichever is less.

2022- A maximum of $61,000 or up to 25% of business revenue—whichever is less.

PROs

  • This is one of the simplest ways for business owners to offer retirement savings for themselves and their employees.
  • High contribution limits
  • SEPs are available to businesses of any size and revenue, including sole proprietorships.
  • There are no vesting schedules; the funds contributed to the account become the employees immediately upon funding.
  • Easy and cost effective to administer.

CONs

  • Employees cannot contribute to the account.
  • Business owners must provide a uniform percentage to all employees (including themselves) regardless of position or time of service.
  • Withdrawals before age 59 1/2 result in a 10% penalty.

Simple IRA

The Savings Incentive Match Plan for Employees (SIMPLE) plan earns its title by being arguably the easiest employer-sponsored retirement option to create and administer.
With a SIMPLE IRA or 401k, employees have the option to contribute pre-tax money to the account, and the money grows tax-deferred until they withdraw it. The employer must contribute to the employee’s SIMPLE IRA, this is not optional. They can either match up to 3% of the employee’s pay or contribute the equivalent of no less than 2% of the employee’s compensation, even if the employee chooses not to contribute.

Employee contribution limits are as follows:

2021: $13,500 per year; $16,500 if age 50 or older

2022, $14,000 per year; $17,000 if age 50 or older

PROs

  • Inexpensive and easy administration for employers.
  • There is no vesting schedule.
  • Plans are not subject to nondiscrimination testing, meaning different employees can receive different levels of employer contributions.

CONs

  • Accounts are limited to employees earning over $5,000 at companies that employ less than 100 employees.
  • Employee contribution limits are lower than most other options.
  • Mandatory employer contributions
  • No option for Roth savings

Other Considerations

Depending on your business’s infrastructure and resources, you might offer other retirement options for your employees as well, such as the following:

Cash balance pension plans afford employees the option of a lifetime annuity.

Money purchase plans are akin to profit-sharing and require a defined percentage of the employee’s salary to be contributed by the employer annually.

Employee-owned businesses can offer Simplified Employee Ownership Plans (SEOPs), providing employees ownership in the company.

How to Decide

When choosing a retirement account for your employees, consider your main objective for establishing the plan. Maybe you are looking to attract and retain talent with employee benefits? Or the motivation may be personal in nature to amp up your personal retirement savings while also helping employees.

Think about how your business wants to contribute and to what extent you want to match employee contributions. You also need to decide if you want to offer a defined benefit or defined contribution plan, with each option having different tax implications. There are a wide range of investment options for each plan type, as well as cost structures, so be sure to shop around.

Establishing a retirement plan is typically a decision with long-term implications, so it is important to carefully consider at least your five and ten year business goals to decide which one will work best for your company. For more information on how these plans will affect your business expenses, cash flow, and taxes, you’ll want to connect with an investment advisor and employee benefits coordinator to ensure you take the best approach for your business and its employees.

Sheena Hanson, CFP® - Investment Advisor Representative and CCO

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