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Retirement Plans for Sole Proprietorships

A sole proprietor has a number of retirement savings options designed for smaller businesses. These plans provide a means to maximized tax-preferred savings while offering additional benefits to any employees. Most plans will be familiar to business owners as they are variations on traditional IRAs and 401(k)s.

  1. Types

    • Sole proprietors have three types of retirement plans to choose from: 401(k), Keogh or IRA. Within these categories are several options. 401(k)s can be traditional, multi-member savings plans, SIMPLE 401(k)s or the newer Individual 401(k). Keogh are profit sharing or money purchase pension arrangements. IRAs come in the form of SEP or SIMPLE.

    Features

    • Each retirement plan functions a little differently. Individual 401(k) plans offer the greatest contribution limit but do not allow for additional employee participation (other than spouses working for the business), and you cannot have any full-time non-spousal employees. Traditional and SIMPLE 401(k) plans allow employee participation, but contribution limits are lower. Traditional 401(k) plans are subject to discrimination testing and annual 5500 reporting. SIMPLE plans do not have testing or reporting but are limited to businesses with fewer than 100 employees. 401(k) plans require regular pay period contributions and must use a trust and recordkeeper to secure plan assets.

      Keogh plans are employer contribution plans. Employers may choose elective (variable) contributions through a profit sharing arrangement or a set contribution via a money purchase plan. Neither plan allows employee contributions.

      SEP and SIMPLE IRAs offer the savings and tax-deferral benefits of regular IRAs but with additional employer contributions and higher contribution limits. SEP IRAs require regular employer contributions of up to 20 percent of pay for all employees and do not allow additional contributions over the set percentage. SIMPLE IRAs allow salary deferral contributions, but at a lower level than SEP IRAs. SIMPLEs also require a set two or three percent additional employer contribution.

    Benefits

    • 401(k) plans typically allow plan loans of up to $50,000, giving access to savings should the need arise. Employees pay back the loan at a set rate over time and the interest goes into their own account. 401(k) plans may be designed to allow Roth after-tax contributions in addition to traditional contributions that allow the saver to diversify future tax obligations. 401(k) plans can also consolidate retirement savings, as they accept rollovers from SEP, SIMPLE and traditional IRAs as well as traditional and SIMPLE 401(k)s.

      Keogh plans typically have vesting schedules, meaning that employees must remain with the company for a set period of time to receive the full benefit. This provides an incentive to stay with the company and can decrease turnover.

      IRAs offer simplicity - trusts and recordkeeping are not required - and this simplicity typically results in lower costs. Distributions are allowed at any time, although premature distributions may result in an IRS penalty.

    Considerations

    • The right retirement plan depends greatly on the nature of your business. If you are an independent contractor and do not plan to hire full-time employees, you may do best with an individual 401(k). If, however, you have several key employees whom you'd like to retain, a SIMPLE 401(k) or IRA may be the best choice. Consider as well your long-term business goals. If you plan to grow your business, it may be best to set up a traditional 401(k) or Koegh plan to attract quality employees at the right time.

      Also consider the impact of each plan on your personal ability to save. Some plans may impose limits that prevent you from setting aside as much as you'd like. It is worth noting that none of these plans prevents you from having a separate, individual Roth or traditional IRA.

    Warning

    • IRS rules vary significantly from plan to plan. Review IRS Publication 560 (Resources 1) and all plan documents thoroughly before finalizing any agreement.

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