Retirement Deeper Dive Part 2: How do I choose the right plan?

By following the flowchart above, you can find the scenario that most closely resembles your situation to aid in your decision-making:

• Scenario A: It is just me or me and my spouse. I’m also under 40.
• Scenario B: It is just me or me and my spouse. I’m also 40 or older.
• Scenario C: You want to be able to vary the employer contribution (if any) every year.
• Scenario D: You want a set contribution level every year.

Scenario A: It is just me or me and my spouse. I’m also under 40.

When you are younger and only considering retirement options for you and your spouse, there are several options to maximize the benefits. This includes saving for a longer period of time than those starting to save for their retirement at an older age.

2. SEP IRA

If you want to contribute additional savings, you may want to add a SEP IRA. These plans are very easy and fast to set up and rarely have fees. There are no annual filing requirements, making it easy to manage. SEP IRA contributions are treated like they are made by the business (not you individually), so these contributions are all allowable business expenses. The contribution limit differs based on the type of company you have:

• Sole proprietors and owners of single member LLCs can contribute up to 20% of their net profit.
• S corporation owners and those with LLCs declared as S corporations can contribute up to 25% of their W-2 wages (not the owner’s draw or distribution).

Total contributions may not exceed $66,000 in 2023.

If you want to be able to contribute more, an Individual or Solo 401(k) can also be a choice. They may take a little more time to set up, but rarely have fees. The Solo 401(k) is inexpensive, easy to set up, and you can contribute as an employer and employee. This creates the ability to save quickly if needed.

For 2023, you can contribute:

• As an employee up to $22,500 ($30,000 if you are over 50); and
• As an employer up to 20% of your employment income.

All of these funds won’t be taxed in the year the contribution will be made, but you will be taxed in retirement.

If your spouse works with you, they can also participate in either the SEP IRA or Solo 401(k).

Scenario B: It is just me or me and my spouse. I’m also 40 or older.

As you get older, it makes more sense to maximize the deduction in the current year. This is because you are making more money and there is less time until you retire for the accumulation of compound interest. For those over 40 without employees, we suggest flipping your strategy.

1. SEP IRA

Start with contributions to a SEP IRA. They are easy to set up, rarely have fees, and have no annual filing requirements. The SEP IRA only has employer-side contributions, and they are limited to:

• 20% of your net profit, for sole proprietors and owners of single member LLCs.
• 25% of your W-2 wages (not your owner’s draw or distribution) for S corporation owners and those with LLCs declared as S corporations.

Total contributions cannot exceed $66,000 in 2023.

2. 401(k)

If you want to contribute higher amounts of pre-tax income, look at an Individual or Solo 401(k). Solo 401(k)s are now much easier to have and the fees are low or none at all. They also have the potential for some of the largest contributions of any retirement plan.

You can contribute as an employer and employee. For 2023, you can contribute as an employee up to $22,500 ($30,000 if you are over 50) and as an employer up to 20% of your self-employment income. The contributions made now won’t be taxed, but you will be taxed in retirement. If your spouse works with you, they can also participate in your Solo 401(k).

3. Roth IRA

If you want to diversify your retirement savings or you have maxed out your Solo 401(k) contributions, you should consider a Roth IRA. Contributions are taxed this year, but all of the gains you have will be tax-free at retirement.

You can contribute $6,500 ($7,500 if you are 50 or older) in 2023. You will need to make $153,000 or less if you are single or head of household and $228,000 or less if you are married filing jointly to participate.

Scenario C: You have employees and you want to be able to vary the employer contribution (if any) every year.

If you want an option to vary the employer contribution you are making toward your employees’ retirement accounts, a good choice is a SEP IRA.

1. SEP IRA

The SEP IRA is a retirement plan that is easy-to-implement and inexpensive. This plan allows you to contribute up to 25% of your employees’ salary per year. The SEP IRA allows you to contribute any level up to 25% in a year or none at all.

Example: You could provide employees with a contribution of 3% of their salary in 2020, none in 2021, 8% in 2022, and then 3% again in 2023.  

Employees are vested in a SEP IRA from day one, so if they leave, they get all the contributions you made. There is no way for employees to do their own contributions because everything is provided by the employer only.

Scenario D: You want a set contribution level every year.

You may wish to provide the same contribution every year. In this case, there are two retirement plans that we recommend you consider.

1. Simple IRA

The first option is a Simple IRA. They are low-cost and require no annual filings or other paperwork. Employees can make contributions directly from their pay up to $15,500 in 2023 (employees over 50 can contribute an additional $3,500 more). The employee contributions are pre-tax, so they don’t pay tax now, but will when they withdraw the funds.

Employers must choose one of two options for their match:

• 2% nonelective contributions. This means you must provide contributions for 2% of an employee’s salary whether they save any money themselves or not.
• A one-for-one match between 1% and 3% of an employee’s salary. This means you only contribute as the employee contributes up to the maximum. The match can only be 1% for two of every five years.

Here are examples of each option:

• Erin chooses 2% nonelective contributions. She has an employee who makes $45,760, so Erin will need to contribute $915.20 no matter how much the employee contributes, if anything at all.

• Joanna offers a 3% match. Her employee makes $45,760. The employee contributes $2,288 each year (5% of her salary). Joanna will need to match the full amount up to the 3% ($1,372.80). If the employee did not make any contributions, Joanna would not contribute.

You can change the amount you are contributing but you must notify employees 60 days ahead of time.

2. 401(k)

If you want to contribute more as an employer or have vesting options (require employees to stay a certain amount of time in order to keep the employer retirement contributions), you should look at a 401(k) Plan. This may be the best-known business retirement plan. It can take time and money to set up and maintain a 401(k) Plan since annual filings and other documentation may be required.

To their advantage, they offer:

• Higher contribution limits. Up to $22,500 in 2023 (with an additional $7,500 for employees over 50).
• Higher employer contribution limits. Depending on the plan you can contribute or match up to 100% of an employee's salary to a total of $66,000.
• Greater versatility. Some plans allow you to make both pre- and post-tax contributions.

Whether you go with a Simple IRA or a 401(k), ask your tax preparer about the Retirement Plan Startup Costs Tax Credit. This will enable you to get up to $5,000 in administrative costs covered and a credit of up to $1,000 per employee in the first year of the plan and additional credits for the next three years.

Are there other types of retirement plans to consider?

There are retirement programs that are not included in the above scenarios. There are reasons why they are not commonly preferred, but it is important to understand how they work to determine whether they are right for you:

• Traditional IRAs can be great for the individual investor but for individuals, the annual contribution limits are lower than an Individual or Solo 401(k), which means you can’t save as much per year.

Contributions from your personal income are considered tax-deductible, but these dollars are still taxed as they “leave” your company (for example, through self-employment tax). Contributions to a Solo 401(k) made directly from your business are not taxed when they leave your company. Because of this, it is less common for businesses to choose a Traditional IRA over an Individual or Solo 401(k).

• Mega Roth backdoor conversions, profit sharing, and defined benefit plans are hard to understand, may involve the commitment of large amounts of money over time, and suggestions to use them are based on your personal financial situation. If you have an interest in these, you should consult with your investor or financial manager.

I’ve selected a plan type. How do I get started?

Now that you’ve determined what option or options to consider, what do you do next? The answer depends on your comfort level and the size of your company. It may be as simple as signing up for a plan online. Most of the major plan providers such as Fidelity, Charles Schwab, Guideline, and Vanguard have made it simple to set up a plan yourself in just a few minutes. They will help you choose or suggest investments so you can start building your savings.

You may wish to receive support from a financial advisor to review your options. Financial advisors may be helpful in making choices on retirement, but make sure you ask the right questions as you are selecting who to use. There can be hidden fees that you may not be aware of up front, so be sure to ask about how the advisor gets paid.

It is important that you understand how you can request paperwork for your accounts if you need to change advisors. You will want to know if an advisor is credentialed. Usually, advisors will be a Certified Financial Planner^Ò, which requires study, passing hard exams, and sticking to a code of professional ethics.

Whether you start your own account online or use an advisor, you’ll want to take the following steps:

• Ask friends, family, and other business owners for recommendations. This can be the best way to find a reliable financial advisor or a reputable vendor. You will be able to find out what they have liked and disliked about their experience.
• Search online for options. The internet can be very useful in finding options that you would not have known about otherwise. Use a search engine (Google, etc.) and/or social media site to expand your choices.
• Read online reviews from other customers. Online reviews can be helpful in choosing a financial advisor or retirement plan vendor. Are the same things mentioned by people leaving reviews? Consider the pros and cons that were shared to help you decide which option is right for you.
• Review the details. Once you’ve found a few options that interest you, explore the options included with the service. How much support are you looking for? Is it difficult to get in touch with someone when needed? Are the plans easy to modify to suit your needs? Is there an app or a user-friendly platform where you can access your plan details? Ask as many questions as you need to feel comfortable. When talking with a potential financial advisor, do they talk down to you or are they taking your business seriously?
• Determine the cost. At the end of the day, make sure that you can afford the option you’ve selected. Compare the options you like best to see if one offers more value for the price.

Choosing the right retirement plan can help you maximize retirement for yourself and/or support the long-term retention of your employees. To understand more about the next steps, see Retirement Part 3: How do I maximize my savings?

Additional Resources

Retirement Basics

Employee Benefits

Attract the Best Talent

The Employee Retention Tax Credit

The Families First Coronavirus Response Leave Act

Paying Yourself

Disclaimer: The information contained here has been prepared by Civitas Strategies and is not intended to constitute legal, tax, or financial advice. The Civitas Strategies team has used reasonable efforts in collecting, preparing, and providing this information, but does not guarantee its accuracy, completeness, adequacy, or currency. The publication and distribution of this information is not intended to create, and receipt does not constitute, an attorney-client or any other advisory relationship. Reproduction of this information is expressly prohibited.