401(k) Alternatives for Small Business Owners

401(k) plans are universally one of the most used retirement planning vehicles, and for good reason. They provide access to great investment choices, flexibility, and personalization, all at a low cost. However, a 401(k) is not always the best option for a small business. Employer contributions can provide great tax benefits, but unpredictable cash flows can limit the effectiveness of a 401(k) plan. There is also an administrative burden to running a 401(k) plan, and many small business owners fail to take their fiduciary responsibility into consideration. While it may seem like an arduous task, there are many feasible options for alternative retirement plans. Ultimately, choosing the best retirement plan alternative comes from understanding how you want to navigate the volatile waters of life into retirement and what vehicle is best suited to get you there.

1. SEP IRA vs. 401(k)

The first option is a SEP IRA, aka Simplified Employee Pension. SEP IRAs are best suited for companies with a small number of employees. They reduce administrative responsibility, while giving you great tax benefits. All employees must receive the same contribution to the plan by the business. This is specifically useful for those who are self-employed and want to maximize their contributions. Much like Traditional IRAs, contributions to SEP IRAs are tax deductible. The contribution limit for a SEP IRA is much higher than other IRA alternatives and is the lower of $61,000 or 25% of compensation (as of 2022). In comparison, the 401(k) contribution limit for workers under 50 is $20,500 each year. If you're interested in reading more, Titan.com published an article breaking down contribution limits, tax implications, and participation rules in an article titled: ”What Are the SEP IRA Contribution Limits for 2022?”.

2. SIMPLE IRA vs. 401(k)

The second option is a SIMPLE IRA, aka Savings Incentive Match Plan for Employees IRA. A SIMPLE IRA is generally used for plans with less than 100 participants, costs less than a 401(k), and has no fiduciary responsibilities. This can be a fantastic way to save your employees money, while also keeping your costs low. The drawbacks include mandatory employer matching contributions, lower contribution limits, no loan option, and a higher penalty for taking funds out prior to the age of 59 1/2. Employees can contribute a maximum of $14,000. The biggest drawback is the two-year waiting period for rollovers, making this type of plan inflexible for retirees. However, SIMPLE IRAs do have real benefits in the ease of requirements on the paperwork and maintenance side. Generally this type of IRA is heavily dependent on the priorities of the employer as it is a less generic plan type, but can be a great alternative for specific small business retirement plans.

3. Solo 401(k) vs. Traditional 401(k)

The third option is a One-Participant 401(k) or Solo 401(k). Like the name implies, this type of plan is for sole proprietors. While similar to a SEP IRA, the plans differ based on how you can contribute and defer tax on the $61,000 contribution limit. That $61,000 is combined with W-2 deferral contributions, as well as end-of-year profit sharing contributions. You can opt to be taxed like a Traditional 401(k) or a Roth Solo 401(k). Your tax style will depend upon whether you want your tax break on the front end, or the back end. Other than that, a One-Participant plan is much like a normal 401(k), just for one person.

4. Traditional IRA vs. 401(k)

The fourth option is a Traditional IRA. This is available as a company and personal account. With a Traditional IRA you contribute pre-tax dollars, and the money grows tax deferred. Depending on your marital status and retirement plan, the amount you are able to deduct varies. Nerdwallet breaks down how marital status and deduction limits in an article titled: ”Traditional IRA Definition, Rules and Options”. You are not taxed on gains until you withdraw them. The contribution limit for Traditional IRA’s is $6,000, $7,000 if you’re age 50 or older. One of the biggest requirements of a Traditional IRA is that you must take the required minimum distributions (RMDs), at age 72. The up front tax benefits make Traditional IRAs a very popular form of retirement plan.

5. Roth IRA vs. 401(k)

The fifth option is a Roth IRA. This type of plan is also available as both a company and personal account. With a Roth account, your money is contributed after tax and can be withdrawn in retirement tax-free. However, contributions are not tax deductible. The salary limit is around $140k for singles and $210k for married people. The contribution limit is $6,000 per year, $7,000 if you’re age 50 or older. In a Roth, there are no required minimum distribution rules unless you inherit an account. This account can be extremely helpful with people who expect their tax rate to be much higher during retirement than it is currently. If you would like a more thorough explanation of this type of account and what it offers, Business Insider wrote an article breaking it down further titled: ”What is a Roth IRA? How to take advantage of after-tax benefits when saving for retirement”. This is an especially prudent way to get ahead of the curve when you are young to set yourself up well in retirement.