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what is a defined contribution plan for small businesses with fewer than 100 employees

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What's a defined contribution plan and how to choose one

A defined contribution (DC) plan is a type of retirement plan that can be provided by an employer for its employees. It enables participants in the plan to make their own contributions or receive employer contributions on a tax-deferred basis. Both large and small businesses—even a one-person shop—can sponsor a DC plan, and there are several plan types to choose from. Deciding which is suitable for your business starts with learning how DC plans work and the differences among the various types.

what is a defined contribution plan for small businesses with fewer than 100 employees

How DC plans work

With a DC plan, money is contributed to an employee (plan participant) account and invested in one of the investments offered by the plan. The contributions, plus any investment earnings, are available to the participant in retirement or, in some cases, while in service with the employer. The participant generally controls how much money they contribute, how they invest, and how they take it out. You—as the plan sponsor—generally control how much, if anything, your business contributes to participant accounts. These plans are called defined contribution because contributions are specified ( defined ). 

ERISA and DC plans

Certain employer-sponsored DC plans are qualified , meaning the plan qualifies for special tax treatment under Section 401(a) of the Internal Revenue Code. In addition, they’re covered by the Employee Retirement Income Security Act of 1974 (ERISA) , which is a federal law that protects employee retirement benefits by imposing reporting, disclosure, and legal ( fiduciary ) requirements. Under ERISA, you have a legal duty to manage an ERISA-covered DC plan prudently and for the exclusive benefit of its participants. In exchange, qualified DC plans have the following tax benefits for both your business and your employees:

  • Contributions are tax deductible for your business and for participants (up to limits in both cases), and
  • Participants aren’t taxed on investment gains until retirement.

The rise of DC plans

DC plans have come to dominate the American retirement landscape, overtaking the traditional pension plan, which is a defined benefit (DB) plan.

In 1980, there were about 148,000 DB plans and 341,000 DC plans. As of 2017, there were fewer than 47,000 DB plans and more than 662,000 DC plans.

Source : “Private Pension Plan Bulletin Historical Tables and Graphs 1975–2017,” Employee Benefits Security Administration, U.S. Department of Labor, dol.gov/sites/dolgov/files/ebsa/researchers/statistics/retirement-bulletins/private-pension-plan-bulletin-historical-tables-and-graphs.pdf , September 2019.

Getting to know IRA-based and ERISA-covered DC plans

Although all qualified DC plans are subject to ERISA guidelines, IRA-based plans aren’t required to follow all of its rules. So, DC plans fall into two main categories: IRA-based plans and ERISA-covered plans.

ERISA-covered plans

ERISA-covered plans are protected by federal law, and, thus, carry reporting and legal responsibilities. You can customize an ERISA-covered plan by deciding which plan features and services to offer, and by selecting investments suited to your participants. But because you control plan features, ERISA-covered plans are subject to annual discrimination testing—this ensures that a plan doesn’t discriminate in favor of highly compensated or key employees.

The four main categories of ERISA DC plans are profit-sharing, profit-sharing 401(k), safe harbor 401(k), and Savings Incentive Match Plan for Employees (SIMPLE) 401(k) plans— the last of which is exempt from nondiscrimination testing.

Profit-sharing plans consist of accounts controlled by employees, into which you make either optional (discretionary) or fixed contributions. Although employer contributions don’t need to be mandatory, they need to be substantial and recurring. They must also be uniform or they’ll be subject to IRS nondiscrimination testing. Employer contributions can’t exceed the lesser of 25% of compensation or $57,000 in 2020.

A 401(k) plan is a profit-sharing plan with an employee salary deferral component. A 401(k) permits employees to delay paying taxes on a portion of salary that they contribute to the plan. You can also allow Roth contributions, which along with associated earnings, are tax free if the participant meets certain conditions at withdrawal of the funds.

Generally, participants can access their contributions before retirement, as well as if they meet the conditions for a hardship withdrawal or if the plan offers loans. Contributions are limited to $57,000 from all sources, and employee contributions are limited to $19,500—plus an additional $6,500 catch-up for participants age 50 or older in 2020.

A safe harbor 401(k) works like a traditional profit-sharing 401(k), although it may not have a profit-sharing component. But it’s exempt from IRS nondiscrimination testing requirements, as long as you make a mandatory employer contribution according to one of the two following formulas, generally with immediate vesting:

  • An annual employer match contribution of at least 100% on the first 3% of compensation, plus 50% on deferrals between 3% and 5%; or
  • A nonelective contribution of 3% of compensation across the board

Contributions are subject to the same limits that apply to profit-sharing 401(k) plans.

SIMPLE 401(k) plans combine some of the features of SIMPLE IRAs and profit-sharing 401(k) plans. They’re exempt from nondiscrimination testing and allow for employee loans and withdrawals. But you must either make a matching contribution of up to 3% of eligible employees’ pay or a nonelective contribution of 2%. And SIMPLE 401(k) salary deferrals are less generous than traditional 401(k) maximums, topping out at $13,500 in 2020, with a $3,000 catch-up. Total contributions are limited to the lesser of 25% of salary or $57,000.

IRA-based plans

An IRA is a tax-favored retirement account established and managed by an individual. IRA-based employer retirement plans are IRAs that employers can contribute to on behalf of their employees. They’re easy to maintain because you have no administrative involvement—the accounts are handled by an IRA provider (usually a bank or financial institution), and the employee chooses their own investments. Since accounts are individually owned and controlled, IRS reporting and disclosure requirements are minimal, and IRS nondiscrimination testing isn’t required.

There are two main types of IRA-based DC plans: the simplified employee pension, or SEP IRA, and the SIMPLE IRA.

SEP IRAs are funded with optional employer contributions only, and those contributions must vest (i.e., become the property of an employee) immediately. Employer contributions are limited to the lesser of 25% of compensation or $57,000 (in 2020), and they must be uniform.

SIMPLE IRAs are funded with both employer and employee contributions (the latter made according to a salary reduction agreement), and employer money is always 100% vested. If you offer a SIMPLE IRA, you can’t offer any other retirement plans, and you must have no more than 100 employees. SIMPLE IRA employer contributions must follow one of two formulas:

  • A matching contribution of up to 3% of compensation, which isn’t subject to any annual limit), or
  • A 2% nonelective contribution—which means independent of whether the employee contributes—for each eligible employee

Employee salary deferrals in a SIMPLE IRA are limited to $13,500, plus a $3,000 catch-up for employees age 50 or older. Total contributions are limited to the lesser of 25% of salary or $57,000.

Who’s eligible for a DC plan?

Federal law generally sets ERISA-qualified DC plan eligibility requirements , although you have some flexibility. Typically, your ERISA plan can’t exclude:

  • Anyone age 21 or older with at least one year of service, or
  • A part-time employee who worked at least 1,000 hours over a 12-month period, as defined in the plan document.

For administrative convenience, you can delay participation for up to six months after eligibility requirements are met or until the start of the next plan year, whichever comes first. And you can create different plans for union and nonunion groups.

SIMPLE IRAs must include employees who received at least $5,000 in compensation during any two preceding calendar years (consecutive or not), and who you expect will earn $5,000 in the current year. SEP IRAs must include any employee age 21 or older who worked for you in any three of the last five years and earned at least $600 in each of those years. 

Which DC plan is suitable for your small business?

Deciding which DC plan to offer depends on a few things—including how much flexibility you want it to have, how much time you can spend sponsoring a plan, the size of your company, and how much money you can contribute to the plan. You’ll also need to decide how important helping your employees achieve retirement readiness is to you, as it will guide your plan choice, eligibility rules, and contribution rates. IRA-based plans are low maintenance, but inflexible. ERISA-qualified plans are available to companies of any size, and they can be customized and grow with your business. But ERISA-based plans carry additional responsibilities, and you have to be ready to handle these yourself—or get expert assistance. Consider consulting a benefits or financial professional to help you decide which plan is best for your employees and for your business.

The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

MGTS-P43252-GE  09/20 43252   MGR0923201323062

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What Is a SIMPLE IRA Plan? How It Works, Rules & FAQs

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A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) can be a way for small-business employees and self-employed people to save for retirement. Although more similar to a traditional IRA than a 401(k) plan offered by larger employers, this workplace retirement savings account allows both employee and employer contributions.

what is a defined contribution plan for small businesses with fewer than 100 employees

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What is a SIMPLE IRA?

A SIMPLE IRA is a type of tax-deferred retirement plan for small businesses with fewer than 100 employees. While it is considered an employer-sponsored retirement plan — and employer contributions are mandatory — its investment, distribution and rollover rules make it more similar to a traditional IRA .

Employees might like that employer match, but they may be less happy about the lower contribution limits, compared with 401(k)s . They may also lament the lack of a Roth version.

Additionally, if you work for yourself, you’re also allowed to contribute to a SIMPLE IRA, although there may be better retirement plan options for self-employed people .

SIMPLE IRA vs. traditional IRA

SIMPLE IRAs bear some similarities to traditional IRAs. Contributions are tax-deferred, meaning the amount you save up to your contribution limit reduces your taxable income for the year, and investment growth is tax-deferred until you start taking distributions after age 59 ½.

SIMPLE IRA vs. 401(k)

In some ways, SIMPLE IRAs are like 401(k) plans: Eligible employees indicate how much (if anything) of each paycheck they want to contribute to the account, and the money is automatically diverted into the worker’s individual investment account. The big difference is how much employees can contribute.

SIMPLE IRA contribution limits for 2023

The employee contribution limit for a SIMPLE IRA in 2023 is $15,500. People age 50 and older can make an additional $3,500 catch-up contribution.

Employer contributions are mandatory and can be made using one of two methods:

Provide matching contributions up to 3% of the employee’s pay, not limited by any annual compensation limit.

Make nonelective contributions equal to 2% of the employee’s compensation based on a maximum salary of $330,000 in 2023.

Employer contributions need to be made by the federal income tax deadline , usually around mid-April, or by the extension date if applicable.

SIMPLE IRA contribution limits for 2024

The employee contribution limit for a SIMPLE IRA in 2024 is $16,000. People age 50 and older can make an additional $3,500 catch-up contribution.

Make nonelective contributions equal to 2% of the employee’s compensation based on a maximum salary of $345,000 in 2024.

Starting in 2024, employers can make additional contributions to each employee, as long as the contribution does not exceed the lesser of up to 10% of compensation or $5,000 [0] Senate.gov . SECURE 2.0 Act of 2022 . Accessed Nov 6, 2023. View all sources .

Employer contributions need to be made by the income tax deadline, or by the extension deadline if applicable.

» Thinking about the future? Learn about succession planning for your business .

Benefits of a SIMPLE IRA

Benefits for employers.

For employers, SIMPLE IRAs have start-up and operating costs that are generally lower than setting up a 401(k) plan. Employers get a tax deduction for their contributions to employees’ accounts.

Benefits for employees

Employees don’t have to sign up for salary deferrals to get the employer contribution if their employer chooses the nonelective 2% contribution option. If the plan uses the elective salary reduction/matching method, the employee must contribute to earn the match.

Eligibility requirements are low. In general, you’re eligible to participate in a SIMPLE IRA if you’ve received at least $5,000 in compensation during any two preceding calendar years and expect to earn at least that much during the calendar year of participation. But the IRS also allows employers to offer these accounts to employees who don’t meet these standards.

Employer contributions vest immediately. With no vesting period, you have 100% ownership of all the money in your SIMPLE IRA.

The IRS lets individuals contribute to other retirement savings plans at the same time. That’s handy if, for example, you have more than one job that offers an employer-sponsored retirement plan or if you also want to contribute to a traditional or Roth IRA .

Investment choices tend to outnumber what’s offered in 401(k)s. Instead of being limited to whatever mutual funds a 401(k) plan administrator chooses, you can invest in stocks, bonds, mutual funds and any other investments offered by the IRA provider.

Drawbacks of SIMPLE IRA plans

The contribution limits for SIMPLE IRA plans are lower than other workplace retirement plans. In 2023, solo business owners can contribute up to $15,500 per year versus $22,500 in a 401(k). For those 50 and older, the difference is a $19,000 limit for the SIMPLE IRA versus $30,000 in a 401(k).

Also, there is no Roth version of the SIMPLE IRA. This is a big drawback given the benefits of Roth IRAs and Roth 401(k)s. (See “ What Is a Roth IRA? ” for more on why we like these accounts.)

Other downsides include:

Participant loans are not allowed.

You’ll pay a steep tax penalty for some early withdrawals. In general, SIMPLE IRA distribution rules mirror traditional IRA rules , except for nonqualified withdrawals within the first two years of your participation. For those, you’ll pay an extra 15% early withdrawal penalty on top of the standard 10% penalty. That means if you tap into the money before age 59 ½ and before you’ve had the plan for two years, you’ll likely owe the IRS 25% of the money you take out in penalties, plus whatever income taxes you owe on it.

Rollovers to another IRA or employer-sponsored retirement plan are subject to strict rules. The 25% penalty mentioned above also applies if you do a rollover into anything other than another SIMPLE IRA during the two-year period after you first participate in the plan.

» Looking to open an IRA? Here are our top picks for the best IRA accounts

what is a defined contribution plan for small businesses with fewer than 100 employees

Is a SIMPLE IRA right for me?

The answer depends on whether you're an employee or the employer.

For business owners: If you're a solo business owner or self-employed and your goal is to maximize your own retirement savings, there are other retirement savings plans that have higher contribution limits:

A solo 401(k) allows a business owner with no employees to contribute up to $66,000 in 2023, with an additional $7,500 catch-up contribution if you’re age 50 or older. The exception to the no-employees rule is if your spouse earns income from your business.

A SEP IRA (Simplified Employee Pension Individual Retirement Account) is a lot like a SIMPLE IRA. But like a solo 401(k), the contribution limits are much higher: You’re allowed to contribute either 25% of compensation or up to $66,000 in 2023.

If you own a small business with employees, a SIMPLE IRA might be attractive if you want to offer your employees a retirement plan but would like to avoid the extra administrative costs that can come with a 401(k). Just keep in mind that some employees may still want a 401(k) because of its higher contribution limits.

In 2024, the Secure 2.0 Act will make it easier to replace SIMPLE IRA offerings with 401(k)s: Employers can make the switch mid-year, rather than at year-end, so long as the new 401(k) plan is in place by the time the SIMPLE IRA is terminated [0] senate.gov . SECURE 2.0 Act of 2022 . View all sources .

For employees: Anyone who has access to the plan at work and wants to maximize their savings may want to consider participating in the SIMPLE IRA plan to get the free money.

If your plan provides the automatic 2% employer contribution, you’ll get that money even if you elect not to divert any of your salary. If the employer contribution is offered by matching funds, you must sign up to contribute a portion of your salary to earn the match. (Remember: You can still save in other types of retirement savings accounts in addition to a SIMPLE IRA.)

» Read more about how to choose between a SIMPLE IRA and a 401(k)

On a similar note...

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401(k) Plans For Small Businesses

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Why 401(k) Plans?

401(k) plans can be a powerful tool to promote financial security in retirement. They are a valuable option for businesses considering a retirement plan, as they provide benefits to both employees and their employers.

A 401(k) plan:

  • Helps attract and keep talented employees.
  • Allows participants to decide how much to contribute to their accounts.
  • Benefits a mix of rank-and-file employees and owners/managers.
  • Helps money grow through investments in stocks, bonds, mutual funds, money market funds, savings accounts, and other investment vehicles.
  • Offers significant tax advantages (including deduction of employer contributions and deferred taxation on contributions and earnings until distribution).
  • Allows participants to take their benefits with them when they leave the company, easing administrative responsibilities.

This publication provides an overview of 401(k) plans. For more information, resources for both you and your employees are listed at the end of this booklet.

Establishing a 401(k) Plan

When you establish a 401(k) plan, you must take certain basic actions. One of your first decisions will be whether to set up the plan yourself or to consult a professional or financial institution – such as a bank, mutual fund provider, or insurance company – to help you establish and maintain the plan. In addition, there are four initial steps for setting up a 401(k) plan:

  • Adopt a written plan document,
  • Arrange a trust for the plan's assets,
  • Develop a recordkeeping system, and
  • Provide plan information to eligible employees.

Adopt a written plan document – Plans begin with a written document that serves as the foundation for day-to-day plan operations. If you hired someone to help with your plan, they will likely provide the document. If not, consider getting assistance from a financial institution or retirement plan professional. In either case, you will be bound by the terms of the plan document.

Once you have decided on a 401(k) plan, you will need to choose the type of plan best for you – a traditional 401(k) plan, a safe harbor 401(k) plan, or an automatic enrollment 401(k) plan. In all the plans, participants can contribute through salary deductions.

A traditional 401(k) plan offers the most flexibility. Employers can decide whether to contribute for all participants, to match employees' deferrals, to do both, or to do neither. These contributions can be subject to a vesting schedule, which means an employee only has a right to employer contributions after a certain amount of time. Annual testing ensures that benefits for rank-and-file employees are proportional to benefits for owners/managers.

Safe harbor 401(k) plans are not subject to the annual contributions testing that traditional 401(k) plans require. In exchange for avoiding annual testing, employees in these plans must receive a certain level of employer contributions. Under the most popular safe harbor 401(k) plan, employees are immediately vested in employer contributions.

An automatic enrollment 401(k) plan allows you to automatically enroll employees and place their salary deductions in certain default investments unless the employee elects otherwise. This is an effective way for employers to increase participation in their 401(k) plans.

The traditional, safe harbor, and automatic enrollment plans are for employers of any size.

This booklet addresses traditional and safe harbor 401(k) plans. For more information on automatic enrollment 401(k) plans, see Automatic Enrollment 401(k) Plans for Small Businesses (Publication 4674).

Once you have decided on the type of plan for your company, you have flexibility in choosing some of the plan's features, such as which employees can contribute to the plan and how much. Other features are required by law. For instance, the plan document must describe certain key processes, such as how contributions are deposited in the plan.

Arrange a trust for the plan's assets – A plan's assets must be held in trust to assure that the assets are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments, and distributions. Because the financial integrity of the plan depends on the trustee, selecting a trustee is one of the most important decisions you will make in establishing a 401(k) plan. If you set up your plan through insurance contracts, the contracts do not need to be held in trust.

Develop a recordkeeping system – An accurate recordkeeping system will track and properly attribute contributions, earnings, losses, plan investments, expenses, and benefit distributions. If a contract administrator or financial institution assists in managing the plan, that entity typically will help keep the required records. In addition, a recordkeeping system will help you, your plan administrator, or your financial provider prepare the plan's annual return/report that must be filed with the Federal Government.

Provide plan information to employees eligible to participate – You must notify employees who are eligible to participate in the plan about certain benefits, rights, and features.

In addition, a summary plan description (SPD) must be provided to all participants. The SPD is the primary way to inform participants and beneficiaries about the plan and how it operates. It typically is created with the plan document. (For more information on the required contents of the SPD, see Disclosing Plan Information to Participants .)

You also may want to provide your employees with information that discusses the advantages of your 401(k) plan. The benefits to employees – such as pretax contributions to a 401(k) plan (or tax-free distributions in the case of Roth contributions), employer contributions (if you choose to make them), and compounded tax-deferred earnings – help highlight the advantages of participating in the plan.

A 401(k) plan may be established as late as the due date (including extensions) of the company's income tax return for the year you want to establish the plan.

For example, if your business's fiscal year ends on December 31, 2022, and you filed for the automatic 6-month extension, the company's tax return would be due on October 15, 2023. You could adopt a plan in 2023 as late as October 15 and make it effective on December 31, 2022. You're not allowed to have 401(k) salary deferrals prior to the date you adopt a 401(k) plan. However, you could make an initial profit sharing contribution to the 401(k) plan for 2022, no later than October 15, 2023.

Operating a 401(k) Plan

Once you establish a 401(k) plan, you assume certain responsibilities in operating it. If you hired someone to help set up your plan, that arrangement also may include help in operating the plan. If not, you'll need to decide whether to manage the plan yourself or to hire a professional or financial institution to take care of some or most aspects of operating the plan.

Elements of operating 401(k) plans include:

Participation

Contributions, nondiscrimination.

  • Investing the contributions
  • Fiduciary responsibilities
  • Disclosing plan information to participants
  • Reporting to government agencies
  • Distributing plan benefits

Typically, a plan includes a mix of rank-and-file employees and owners/managers. However, a 401(k) plan may exclude some employees if they:

  • Are younger than 21,
  • Have completed less than 1 year of service,
  • Are covered by a collective bargaining agreement, if retirement benefits were the subject of good faith bargaining, or
  • Are certain nonresident aliens.

In all 401(k) plans, participants can contribute through salary deductions. You can decide how much your business contributes to participants' accounts in the plan.

Traditional 401(k) Plan

If you decide to contribute to your 401(k) plan, you have options. You can contribute a percentage of each employee's compensation (a nonelective contribution), you can match the amount your employees contribute (a matching contribution), or you can do both.

For example, you may decide to add a matching contribution – say, 50 percent – to an employee's contribution, which results in a 50-cent increase for every dollar the employee sets aside.

Using a matching contribution formula will provide employer contributions only to employees who contribute to the 401(k) plan. If you choose to make nonelective contributions, the employer contribution goes to each eligible participant, whether or not the participant decides to contribute to their 401(k) plan account.

Under a traditional 401(k) plan, you have the flexibility of changing the amount of employer contributions each year, according to business conditions.

Safe Harbor 401(k) Plan

Under a safe harbor plan, you can match each eligible employee's contribution, dollar for dollar, up to 3 percent of the employee's compensation, and 50 cents on the dollar for the employee's contribution that exceeds 3 percent, but not 5 percent, of the employee's compensation.

Alternatively, you can make a nonelective contribution equal to 3 percent of compensation to each eligible employee's account.

Each year you must make either the matching contributions or the nonelective contributions. The plan document will specify which contributions will be made, and this information must be provided to employees before the beginning of each year.

Roth Contributions

401(k) plans may permit employees to make after-tax contributions through salary deduction. These designated Roth contributions, as well as gains and losses, are accounted for separately from pretax contributions. However, designated Roth contributions are treated the same as pretax contributions for most aspects of plan operations, such as contribution limits.

A 401(k) plan may allow participants to transfer certain amounts in the plan to their designated Roth account in the plan.

Contribution Limits

Employer and employee contributions and forfeitures (nonvested employer contributions of terminated participants) are subject to a per-employee overall annual limit. This limit is the lesser of:

  • 100 percent of the employee's compensation, or
  • $61,000 for 2022 and $66,000 for 2023.

In addition, the amount employees can contribute under any 401(k) plan is limited to $20,500 for 2022 and $22,500 for 2023. This includes both pre-tax employee salary deferrals and after-tax designated Roth contributions (if permitted under the plan).

All 401(k) plans may allow catch-up contributions of $6,500 for 2022 and $7,500 for 2023 for employees 50 and older.

Employee salary deferrals are immediately 100 percent vested – that is, the money that an employee has contributed to the plan cannot be forfeited. When an employee leaves employment, they are entitled to that money, plus any investment gains (or minus losses).

In safe harbor 401(k) plans, all required employer contributions are always 100 percent vested. In traditional 401(k) plans, you can design your plan so that employer contributions vest over time, according to a vesting schedule.

To preserve the tax benefits of a 401(k) plan, the plan must provide substantive benefits for rank-and-file employees, not just business owners and managers. These requirements are called nondiscrimination rules and compare both plan participation and contributions of rank-and-file employees to owners/managers.

Traditional 401(k) plans are subject to annual testing to ensure that the contributions made for rank-and-file employees are proportional to contributions made for owners and managers. In most cases, safe harbor 401(k) plans are not subject to annual nondiscrimination testing.

Investing the Contributions

After you decide on the type of 401(k) plan, you can consider the variety of investment options. In designing a plan, you will need to decide whether you will permit your employees to direct the investment of their accounts or if you will manage the monies on their behalf.

If you allow participants to direct their investments, you must decide what investment options to make available. Depending on the plan design you choose, you may want to hire someone either to determine the investment options or to manage the plan's investments. Continually monitoring the investment options ensures that your selections remain in the best interests of your plan and its participants.

Fiduciary Responsibilities

Many of the actions needed to operate a 401(k) plan involve fiduciary decisions. This is true whether you hire someone to manage the plan for you or do some or all of the plan management yourself. Controlling the assets of the plan or using discretion in administering and managing the plan makes you and the entity you hire a plan fiduciary. Providing investment advice for a fee also makes someone a fiduciary. Hiring someone to perform fiduciary functions is itself a fiduciary act. Fiduciary status is based on the functions performed for the plan, not a title.

Some decisions for a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan, and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and, in carrying out these actions, may be a fiduciary.

Basic Responsibilities

Fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary's responsibilities include:

  • Acting solely in the interest of the participants and their beneficiaries;
  • Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries;
  • Paying only reasonable plan expenses;
  • Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters;
  • Following the plan documents; and
  • Diversifying plan investments.

These are the responsibilities that fiduciaries need to keep in mind. The responsibility to be prudent covers a wide range of functions needed to operate a plan. Because all these functions must be carried out in the same way a prudent person would, you may want to consult experts in investments, accounting, and other fields, as appropriate.

In addition, for some functions, there are specific rules that help guide the fiduciary. For example, the deductions from employees' paychecks for contribution to the plan must be deposited with the plan as soon as reasonably possible, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter time frame, you must do so.

For plans with fewer than 100 participants, salary reduction contributions deposited with the plan no later than the 7th business day following withholding by the employer will be considered contributed in compliance with the law.

For all contributions — employee and employer (if any) — the plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are transmitted. If the plan and other documents are not clear on this, the trustee generally has this responsibility. In addition, you (or those you hire) will need to update the plan document for changes in the law.

Limiting Liability

With these responsibilities, there is also some potential liability. However, you can take actions to limit your liability and demonstrate that you carried out your responsibilities properly.

The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the results. For example, if you or someone you hire makes the investment decisions for the plan, an investment does not have to be a “winner” if it was part of a prudent overall diversified investment portfolio for the plan. Because a fiduciary needs to carry out activities through a prudent process, you should document the decision-making process to demonstrate the rationale at the time a decision was made.

In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to give participants control of investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. If properly executed, this type of plan limits your liability for participants' investment decisions. You can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability.

Hiring a Service Provider

Even if you do hire a financial institution or retirement plan professional to manage the plan, you retain some fiduciary responsibility for the decision to select and keep that person or entity as the plan's service provider. So, you should document your selection process and monitor the services provided to determine if you need to make a change.

For a service contract or arrangement to be reasonable, service providers must give you certain information about the services they will provide to your plan and all of the compensation they will receive. This information will assist you in understanding the services, assessing the reasonableness of the compensation (direct and indirect), and determining any conflicts of interest that may impact the service provider's performance.

Some additional items to consider in selecting a plan service provider:

  • Information about the firm itself: affiliations, financial condition, experience with 401(k) plans, and assets under its control
  • A description of business practices: how plan assets will be invested if the firm will manage plan investments or how participant investment directions will be handled
  • Information about the quality of prospective providers: the identity, experience, and qualifications of the professionals who will be handling the plan's account; any recent litigation or enforcement action that has been taken against the firm; the firm's experience or performance record; if the firm plans to work with any of its affiliates in handling the plan's account; and whether the firm has fiduciary liability insurance

If your service provider is responsible for maintaining plan records and keeping participant data confidential and plan accounts secure, use a service provider who follows strong cybersecurity practices. To prudently select and monitor such a service provider, ask for:

  • Information about a firm's business practices: its information security standards, practices, policies, and annual audit results available to plan clients; how it validates its practices; and whether it has insurance policies that cover losses caused by cybersecurity and identity theft breaches (whether caused by internal or external threats)
  • Information about the quality of the firm's services: its track record in the industry, including security incidents, other litigation, and legal proceedings related to its services; and for prior security breaches, what happened and how it responded

For more tips for hiring a service provider with strong cybersecurity practices, including terms and provisions recommended for inclusion in service provider contracts, visit DOL's cybersecurity website .

For information on cybersecurity best practices that service providers should follow, see DOL's website .

Once hired, you should continue to monitor your service provider.

  • Evaluate any notices the service provider furnishes about possible changes to their compensation and the other information they provided when hired (or when the contract or arrangement was renewed);
  • Review the service provider's performance;
  • Read any reports they provide;
  • Check actual fees charged;
  • Ask about policies and practices (such as trading, investment turnover, and proxy voting); and
  • Follow up on participant complaints.

For more information, see Understanding Retirement Plan Fees and Expenses .

Providing Information in Participant-Directed Plans

When plans allow participants to direct their investments, fiduciaries need to take steps regularly to make participants aware of their related rights and responsibilities. This includes providing plan- and investment-related information, including information about fees and expenses that participants need to make informed decisions about the management of their individual accounts.

You (or those you hire) must provide that information to participants before they can first direct their investment in the plan and annually thereafter. The investment-related information needs to be presented in a format, such as a chart, that allows for comparison of the plan's investment options. A model chart is available.

If you use information provided by a service provider that you rely on reasonably and in good faith, you will be protected from liability for the completeness and accuracy of the information.

Prohibited Transactions and Exemptions

Some transactions are prohibited under the law to prevent dealings with parties that have certain connections to the plan, self-dealing, or conflicts of interest that could harm the plan. However, there are several exceptions under the law, and additional exemptions may be granted by the U.S. Department of Labor if protections for the plan are in place in conducting the transactions.

One exemption allows fiduciary investment advisers to provide investment advice to participants who direct the investments in their accounts. The exemption applies to buying, selling, or holding an investment related to the advice, as well as to receiving related fees and other compensation by a fiduciary adviser. Please see DOL's website for more information.

Another exemption in the law permits you to offer loans to participants through your plan. If you do, the loan program must be carried out in a way that protects the plan and all other participants. Each loan request decision is treated as a plan investment and considered accordingly.

Anyone handling plan funds or other plan property generally must be covered by a fidelity bond to protect the plan against loss resulting from fraud and dishonesty by those covered by the bond.

Disclosing Plan Information to Participants

Plan disclosure documents keep participants informed about how the plan operates, alert them to changes in the plan's structure and operations, and give them a chance to make decisions and take timely action on their accounts.

The summary plan description (SPD) is a plain-language explanation of the plan and must be comprehensive enough to inform participants of their rights and responsibilities. It also informs participants about the plan features and what to expect of the plan.

Among other things, the SPD must include information about:

  • When and how employees become eligible to participate in the 401(k) plan,
  • The contributions to the plan,
  • How long it takes to become vested,
  • When employees are eligible to receive their benefits,
  • How to file a claim for those benefits, and
  • Participants' basic rights and responsibilities under the Employee Retirement Income Security Act (ERISA).

The SPD should include an explanation about the administrative expenses that will be paid by the plan. The plan administrator must give this document to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.

A summary of material modifications (SMM) informs participants of changes made to the plan or to the information in the SPD. When such changes occur, all participants must automatically receive either an SMM or an updated SPD within a specified number of days after the change.

An individual benefit statement shows:

  • The total plan benefits earned by a participant,
  • Vested benefits,
  • The value of each investment in the account,
  • Information describing the ability to direct investments, and
  • For plans with participant direction, an explanation of the importance of a diversified portfolio.

Plans that provide for participant-directed accounts must furnish quarterly individual benefit statements. Plans that do not provide for participant direction must furnish statements annually.

As noted above, plans that allow participants to direct the investments in their accounts must provide participants with plan and investment information, including information about fees and expenses, before they can first direct investments and annually thereafter. At least quarterly, they also must provide participants with information on the fees and expenses actually paid. The initial plan-related information may be distributed as part of the SPD provided when a participant joins the plan as long as it is provided before the participant can first direct investments. The information provided quarterly may be included with the individual benefit statement.

A summary annual report is a narrative of the plan's annual return/report, the Form 5500, filed with the Federal Government (see Reporting to Government Agencies for more information). The plan administrator must furnish it to participants annually.

A blackout period notice gives employees advance notice when a blackout period occurs, typically when plans change recordkeepers or investment options, or when plans add participants because of corporate mergers or acquisitions. During a blackout period, participants' rights to direct investments, take loans, or obtain distributions are suspended.

You can furnish these disclosures in paper or electronically. To provide them electronically, you may either post them on a plan website or email them to plan participants, after notifying participants that disclosures will be furnished electronically. There are a number of protections for participants receiving electronic disclosures, including the right to request paper copies of disclosures or to opt out of electronic delivery. You also need to take reasonable steps to protect the confidentiality of participants' personal information online. For more information, see DOL's website .

Reporting to Government Agencies

In addition to the disclosure documents that provide information to participants, plans must also report certain information to Government entities.

Form 5500 Annual Return/Report of Employee Benefit Plans

Plans must file an annual return/report with the Federal Government, in which information about the plan and its operation is disclosed to the IRS and the U.S. Department of Labor.

Depending on the number and type of participants covered, most 401(k) plans must file one of the following forms:

  • Form 5500 , Annual Return/Report of Employee Benefit Plan
  • Form 5500-SF , Short Form Annual Return/Report of Small Employee Benefit Plan
  • Form 5500-EZ , Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan

Plans file the Form 5500 or Form 5500-SF electronically through a web-based system called EFAST2. These returns/reports are made available to the public. One-participant plans or foreign plans may file Form 5500-EZ electronically on EFAST2 or on paper with the IRS. Form 5500-EZ returns are not made available to the public.

One-participant plans (which cover only sole proprietors – whether incorporated or not — partners, and spouses) with total assets of $250,000 or less at the end of the plan year are exempt from the annual filing requirement. However, you must file a final return/report if you terminate the plan, regardless of the value of the plan's assets.

Form 1099-R

Form 1099-R , Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is generally used to report distributions (including rollovers) from a retirement plan. It is given to both the IRS and recipients of distributions from the plan during the year.

Form 8955-SSA

Form 8955-SSA , Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits , is used to report separated participants with deferred vested benefits under the plan. It is filed with the IRS. The information is generally given to the Social Security Administration and to each deferred vested participant in an individual statement by the plan administrator.

Distributing Plan Benefits

The amount of benefits in a 401(k) plan is dependent on a participant's account balance at the time of distribution.

When participants are eligible to receive a distribution, 401(k) plans typically allow participants to:

  • Take a lump sum distribution of their account,
  • Roll over their account to an IRA or another employer's retirement plan, or
  • Take periodic distributions.

More employers are offering annuity or other lifetime income distribution options in their defined contribution plans for employees who want to ensure that they do not outlive their retirement savings. You may want to look into what other employers are doing.

Terminating a 401(k) Plan

401(k) plans must be established with the intention of being continued indefinitely. However, business needs may require employers to terminate their plans. For example, you may want to establish another type of retirement plan instead of the 401(k) plan.

Typically, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500. You must also notify your employees that the plan will be discontinued. Check with your plan's financial institution or a retirement plan professional to see what else you must do to terminate your 401(k) plan.

Even with the best intentions, those operating the plan can still make mistakes. The Department of Labor and IRS have correction programs to help 401(k) plan sponsors correct plan errors, protect participants' interests, and keep the plan's tax benefits. These programs are structured to encourage early correction. Having an ongoing review program makes it easier to spot and correct mistakes in plan operations.

See the Resources section for further information.

A 401(k) Plan Checklist

  • Which type of 401(k) plan best suits your business?
  • Will you hire a financial institution or retirement plan professional to help with setting up and running the plan?
  • Will you make contributions to the plan, and, if so, will you make nonelective and/or matching contributions? (Remember, you may design your plan so that you may change your nonelective contributions if necessary due to business conditions.)
  • Have you adopted a written plan that includes the features you want to offer, such as whether participants will direct the investment of their accounts?
  • Have you notified eligible employees and provided them with information to help in their decision-making?
  • Have you arranged a trust for the plan assets, or will you set up the plan solely with insurance contracts?
  • Have you developed a recordkeeping system?
  • Do you understand your fiduciary responsibilities?
  • How will you monitor the plan's service providers and investments?
  • Do you understand the reporting and disclosure requirements of a 401(k) plan?

For help establishing and operating a 401(k) plan, you may want to talk to a retirement plan professional or a representative of a financial institution offering retirement plans. You should also speak to a qualified tax professional about your particular situation and take advantage of the help available in the Resources section.

To find this publication and more information on retirement plans, visit:

The U.S. Department of Labor's Employee Benefits Security Administration

  • Information for small businesses
  • Retirement saving information for employers and employees

Internal Revenue Service

  • Guidance for maintaining your 401(k) plan
  • Retirement Plans Startup Costs Tax Credit
  • 401(k) Plan Checklist

In addition, the following jointly developed publications are available on the DOL and IRS websites or can be ordered electronically or by calling toll-free 866-444-3272:

  • Choosing a Retirement Solution for Your Small Business , Publication 3998, provides an overview of retirement plans available to small businesses.
  • Automatic Enrollment 401(k) Plans for Small Businesses , Publication 4674, explains a type of retirement plan that allows small businesses to increase plan participation.
  • Adding Automatic Enrollment to Your 401(k) Plan , Publication 4721, explains how to add automatic enrollment to your existing 401(k) plan.
  • Payroll Deduction IRAs for Small Businesses , Publication 4587, describes an arrangement that is an easy way for businesses to give employees an opportunity to save for retirement.
  • Profit Sharing Plans for Small Businesses , Publication 4806, describes a flexible way for businesses to help employees save for retirement.
  • SEP Retirement Plans for Small Businesses , Publication 4333, describes a low-cost retirement savings option for small businesses.
  • SIMPLE IRA Plans for Small Businesses , Publication 4334, describes a type of retirement plan designed especially for small businesses.

For business owners with a plan

  • Retirement Plan Correction Programs , Publication 4224, briefly describes the IRS and DOL voluntary correction programs.

Related materials available from DOL

For small businesses.

  • Meeting Your Fiduciary Responsibilities
  • Understanding Retirement Plan Fees and Expenses
  • Selecting an Auditor for Your Employee Benefit Plan
  • Reporting and Disclosure Guide for Employee Benefit Plans
  • Tips for Selecting and Monitoring Service Providers for Your Employee Benefit Plan

In addition, DOL's Small Business Retirement Savings Advisor helps small business owners choose the most appropriate retirement plan for their businesses and provides resources on maintaining plans.

For employees

  • A Look at 401(k) Plan Fees
  • What You Should Know about Your Retirement Plan (also in Spanish, Arabic, Simplified Chinese, Traditional Chinese, French, Haitian Creole, Korean, Polish, Portuguese, Russian, Tagalog, and Vietnamese)
  • Savings Fitness: A Guide to Your Money and Your Financial Future (also in Spanish)
  • Taking the Mystery Out of Retirement Planning (also in Spanish)
  • Top 10 Ways to Prepare for Retirement (also in Spanish, Arabic, Simplified Chinese, Traditional Chinese, French, Haitian Creole, Korean, Polish, Portuguese, Russian, Tagalog, and Vietnamese)
  • Women and Retirement Savings (also in Spanish)

To view these publications, go to DOL's Saving Matters website . To order publications or request assistance from a benefits advisor, contact EBSA electronically or call toll free 866-444-3272.

Related materials available from the IRS

  • Lots of Benefits , Publication 4118, discusses the benefits of sponsoring and participating in a retirement plan (also available in Spanish, Korean, Vietnamese, Chinese, and Russian).
  • Have you had your Check-up this year? for Retirement Plans , Publication 3066, encourages employers to perform a periodic “check-up” of their retirement plans through the use of a checklist, and how to initiate any necessary corrective action.
  • 401(k) Plan Checklist , Publication 4531, a tool to help you keep your plan in compliance with many of the important tax rules.
  • Designated Roth Accounts under 401(k), 403(b), or governmental 457(b) plans , Publication 4530, discusses this popular feature found in many 401(k), 403(b), and governmental 457(b) plans.
  • Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) , Publication 560, describes types of plans, qualification rules, setting up a qualified plan, the minimum funding requirement, contributions, employer deduction, elective deferrals, the qualified Roth contribution program, distributions, prohibited transactions, and reporting requirements.

To view these related publications, go to the IRS's website .

  • What is a SIMPLE IRA? 

How does a SIMPLE IRA work?

  • Contribution limits for 2023
  • Contribution limits for 2024
  • Pros and cons
  • SIMPLE IRA vs. Traditional IRA 
  • The bottom line

SIMPLE IRA: Contribution limits and how it works

Our experts answer readers' investing questions and write unbiased product reviews ( here's how we assess investing products ). Paid non-client promotion: In some cases, we receive a commission from our partners . Our opinions are always our own.

  • A SIMPLE IRA is a type of individual retirement account offered by small businesses.
  • In 2023, SIMPLE IRAs allow for employee contributions up to $15,500 annually ($19,000 for those 50 or older); those numbers increase to $16,000 and $19,500 in 2024.
  • Employers can make matching contributions of up to 3% of the participant's salary.

Insider Today

SIMPLE IRAs are a great option for small business owners who want to help their employees save.

"They are fairly inexpensive to set up and maintain when compared to a conventional retirement plan," says Karina Valido, vice president and private client advisor at First American Bank .

What is a SIMPLE IRA? 

Savings Incentive Match Plans for Employees (SIMPLE) IRAs are a type of individual retirement plan offered by small businesses with fewer than 100 employees. SIMPLE IRAs function similarly to 401(k)s, allowing both employer- and employee-side contributions.

SIMPLE IRAs are set up by employers — specifically, those with 100 or fewer workers. Employees can then contribute a portion of their earnings to the account, and their employer can then match those contributions up to 3% of their salary. 

Employers can also choose "nonelective contributions," which essentially means they'll contribute up to 2% of the employer's salary — even if the employee never contributes to the account themselves.

"For employers, contributions are tax-deductible," Valido says. "For participants, contributions and earnings are not taxed until withdrawn."

Eligibility requirements

With SIMPLE IRAs, there are requirements both for employers and employees.

  • Employer requirements: Employers must be small businesses with 100 workers or fewer, and they cannot offer any additional retirement plans. They must agree to provide a matching contribution up to 3% of employees' salary or 2% in nonelective contributions annually.
  • Employee requirements: To participate in a SIMPLE IRA, employees need to have earned at least $5,000 in the prior two years and expect to receive $5,000 in compensation in the current year.

"There are no income limits for these accounts, so even high-income earners qualify for SIMPLE IRAs," says John Hagensen, founder and previous managing director of Keystone Wealth Partners .

SIMPLE IRA contribution limits for 2023

SIMPLE IRAs do come with contribution limits, though, and these vary by tax year. Here are the limits for for 2023:

SIMPLE IRA contribution limits for 2024

Here are the limits for SIMPLE IRAs in 2024:

Pros and cons of a SIMPLE IRA

As with anything, there are both pros and cons to using a SIMPLE IRA. One major advantage is that employees have full control over what their SIMPLE IRA is invested in. For employers, these accounts are easy to set up, are tax-deductible, and come with few administrative costs.

On the downside, the contribution limits are lower on SIMPLE IRAs than they are on 401(k)s , and there's no Roth version of these IRAs either. As a result, participants may pay higher taxes on their withdrawals down the line (if they're in a higher tax bracket at that point).

Here's a breakdown of all the pros and cons a SIMPLE IRA comes with:

SIMPLE IRA vs. Traditional IRA 

SIMPLE and traditional IRAs are both types of individual retirement accounts, but they're not one and the same. 

"Traditional IRAs are set up by individuals and only that same individual can contribute to it, while SIMPLE IRAs are set up by small business owners," Hagensen says. "Both the employee and employer are able to contribute to that account."

There are also differences in contribution levels and income requirements, and traditional IRAs don't offer employer matching, as SIMPLE IRAs do. Here's a full look at the differences between these two types of accounts:

SIMPLE IRA FAQs

A SIMPLE IRA is a retirement plan offered by small businesses with 100 or fewer employees. The worker can contribute up to $15,000 in 2023 and $16,000 in 2024. If you're age 50 or older, you can contribute up to $3,500 more per year.

A 401(k) is better overall than a SIMPLE IRA because the contribution limits are higher, and the employer may be able to match more of your contributions. But keep in mind that certain small businesses aren't eligible to offer 401(k)s.

Yes, a SIMPLE IRA is an employer-sponsored retirement plan. A traditional or Roth IRA is an individual retirement account you open on your own, and it has lower contribution limits than a SIMPLE IRA.

Should you open a SIMPLE IRA?

If you work for or own a small business, a SIMPLE IRA may be an option for you. These retirement accounts are easy to set up and manage, and they offer low administrative costs, flexible investments, and immediate vesting, too.

Keep in mind, though, they are pre-tax accounts, so if you expect your tax bracket to be higher in retirement, they could result in higher costs. They also come with smaller contribution limits than 401(k)s and SEP IRAs .

what is a defined contribution plan for small businesses with fewer than 100 employees

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  • Retirement Planning

SIMPLE IRA: Definition, How Small Businesses Use, and Drawbacks

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

what is a defined contribution plan for small businesses with fewer than 100 employees

What Is a SIMPLE IRA?

A SIMPLE IRA is a retirement savings plan that most small businesses with 100 or fewer employees can use. " SIMPLE " stands for "Savings Incentive Match Plan for Employees," while IRA is the acronym for individual retirement account. Employers can choose to make a non-elective contribution of 2% of the employee's salary or a dollar-for-dollar matching contribution of the employee's contributions to the plan up to 3% of their salary.

Key Takeaways

  • A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a type of tax-deferred retirement savings plan.
  • SIMPLE IRAs are easy to set up, and they can be a good option for small businesses.
  • They have some drawbacks, and businesses that can afford to set up other plans might consider it.

Understanding the SIMPLE IRA

Employees can contribute a maximum of $15,500 annually in 2023 ($16,000 in 2024). The maximum is increased periodically to account for inflation. Retirement savers ages 50 and older may make an additional  catch-up contribution  of $3,500, bringing their annual maximum to $19,000 in 2023 ($19,500 for 2024).

One of the many major provisions, now law, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, the government will provide a maximum tax credit of $500 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment.

The appeal of SIMPLE IRAs is that they have minimal paperwork requirements, just an initial plan document and annual disclosures to employees. The employer establishes the plan through a financial institution that administers it. Startup and maintenance costs are low, and employers get a tax deduction for contributions they make for employees.

To be eligible to establish a SIMPLE IRA, the employer must have 100 or fewer employees. Those who are self-employed or sole-proprietors are eligible to establish a SIMPLE IRA as well. To participate in the plan, employees must have earned at least $5,000 in compensation in any two previous calendar years and be expected to earn at least $5,000 in the current year. Employers can choose less restrictive participation requirements if they wish. An employer may also choose to exclude from participation employees who receive benefits through a union.

Special Considerations

Employers establish the plan using Internal Revenue Service (IRS) Form 5304-SIMPLE if they want to allow employees to choose the financial institution where they will hold their SIMPLE IRAs, or using Form 5305-SIMPLE if the employer wants to choose the financial institution where employees will hold their IRAs. Employees must fill out a SIMPLE IRA adoption agreement to open their accounts.

Once the plan is established, employers are required to contribute to it each year unless the plan is terminated. However, employers may change their contribution decision between the 2% mandatory contribution and the 3% matching contribution if they follow IRS rules.

SIMPLE IRA Drawbacks

One drawback of SIMPLE IRAs is that the business owner cannot save as much for retirement as with other small business retirement plans, such as a simplified employee pension (SEP) or a 401(k) plan , the latter of which also offers higher catch-up contribution limits. Also, a SIMPLE IRA cannot be rolled over into a traditional IRA without a two-year waiting period from the time the employee first joined a plan, unlike a 401(k).

As of December 2015, SIMPLE IRA accounts are permitted to accept transfers from SEP IRAs, traditional IRAs and employer-sponsored plans such as a 401(k).

Internal Revenue Service. " SIMPLE IRA Plan ."

Internal Revenue Service. “ 2024 Limitations Adjusted as Provided in Section 415(d), etc .” Page 2.

U.S. Congress. " H.R.1865 - Further Consolidated Appropriations Act, 2020 ." Page 616.

Internal Revenue Service. " SIMPLE IRA Plan FAQs ."

Internal Revenue Service. " Rollover Chart ." Page 1.

Internal Revenue Service. " SIMPLE IRA Withdrawal and Transfer Rules ."

what is a defined contribution plan for small businesses with fewer than 100 employees

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Help small businesses choose the right employee retirement plans

Cpas can help business owners make sense of the various options available..

Help small businesses choose the right employee retirement plans

  • Personal Financial Planning
  • Retirement Planning

Retirement plans offer significant tax advantages to small business owners and give them and their employees incentive to save for the future. Several types of retirement plans are available to small businesses, each with its own requirements and restrictions. The same plan is not necessarily ideal for companies of all sizes and ownership structures, so small business owners need to do their homework before making a decision.

As a CPA, you can help business owners select and implement the plan that is most appropriate for them. You can base your recommendations on the unique characteristics of your client's business, such as the owner's retirement goals, how the business is set up (as a sole proprietorship, a limited liability company, a C corporation, or an S corporation), the number of employees, and so on. You can also help them understand the legal and compliance issues related to each type of plan, as well as any tax advantages it might bring.

What follows is an overview of the types of plans, as well as a discussion of issues to consider as you assist small business - owner clients throughout the often - confusing process of choosing a retirement plan.

MAJOR TYPES OF RETIREMENT PLANS

Various types of retirement plans are available to small business owners. The major ones include the following (see the chart, "Comparison of Retirement Plans for Small Businesses," for more details on the four most common types of plans):

Simplified employee pension (SEP) plans

SEPs can be used by businesses with any number of employees. Contributions are made by the employer only (up to the lesser of 25% of each qualified employee's compensation or $55,000 for 2018) and are tax - deductible as a business expense. The primary advantage of SEP plans is how simple they are to administer. After adoption, no annual IRS forms generally need to be filed for a SEP, and administrative costs are minimal.

There are three steps to establishing a SEP. The employer must (1) execute a written agreement to provide benefits to all eligible employees; (2) give employees certain information about the agreement; and (3) set up an IRA account for each employee. The IRS has a model SEP plan document, Form 5305 - SEP , Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement . However, not all employers can use Form 5305 - SEP , and instead some must use a prototype document.

However, SEPs do not allow employees to defer income, and employees are always 100% vested in employer contributions to their SEPs. Therefore, they may not be the best choice for companies in industries with high employee turnover or that want to use a retirement plan to help retain employees. Another potential drawback to these plans is that they require the employer to make contributions at the same percentage to all eligible employees. Because of this requirement, a smaller company with a self - employed owner may lack sufficient cash flow to support such a plan if the owner wants to make a large contribution to his or her SEP.

Savings incentive match plan for employees (SIMPLE) IRA plans

SIMPLE IRAs are generally available to businesses with 100 or fewer employees who received $5,000 or more in compensation in the preceding year. These plans are funded by tax - deductible employer contributions and pretax employee contributions.

As the name implies, SIMPLE IRAs are simple to implement and administer. To implement this plan the employer can use Form 5304 - SIMPLE , Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) — Not for Use With a Designated Financial Institution , or Form 5305 - SIMPLE , Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) — for Use With a Designated Financial Institution . As with Form 5305 - SEP , the employer is required to keep the form in its records but does not file it with the IRS.

A small employer may wish to implement a SIMPLE IRA plan because it allows employees to defer income by making salary reduction contributions (subject to annual limitations) to their SIMPLE IRAs. Another potential advantage to an employer of a SIMPLE IRA plan over a SEP is that it generally requires a smaller contribution on the employer's part. An employer must match each employee's salary reduction contribution dollar - for - dollar up to 3% of the employee' compensation or make a nonelective contribution of 2% of an eligible employee's compensation (up to $275,000 for 2018), regardless of whether the employee makes a salary reduction contribution.

As with SEPs, though, employees are always 100% vested in employer contributions to SIMPLE IRAs, so they may not be the best choice for companies in industries with high turnover.

Qualified plans

Qualified plans are more complex than SEPs or SIMPLE IRAs and, therefore, have more stringent reporting requirements. But they can be more appropriate for larger or growing businesses. Larger businesses generally have the staff and infrastructure to accommodate the required reporting of a qualified plan and, typically, desire features such as loan provisions and in - service withdrawals allowed in qualified plans that are not allowed in a SEP or SIMPLE IRA. There are several types of qualified plans, which can be broken down into two broad categories: defined benefit and defined contribution plans.

Defined benefit plans. Commonly referred to as pension plans, defined benefit plans promise to pay employees a steady income stream at some point in the future. The amount each employee receives is most commonly based on earnings history and length of service. Employers must contribute enough to the defined benefit plan each year to satisfy what's known as a minimum funding requirement. Due to the complexity of the minimum funding calculation and other requirements, administration of a defined benefit plan usually requires professional assistance from an actuary. For that reason, very few small businesses use them.

Defined contribution plans. With defined contribution plans, employers contribute into individual accounts for each employee. Employees generally have the authority to invest the money as they see fit among the investment options provided by the plan. Defined contribution plans do not require immediate vesting of amounts contributed to the plan by employers and may allow employee loans.

Types of defined contribution plans include profit sharing plans and money purchase plans. Under a profit sharing plan, an employer's contributions are discretionary, so the employer is not required to make contributions to the plan each year. Under a money purchase plan, contributions are mandatory, so the employer must make a contribution to the plan each year, and the contribution percentage used to determine the contribution amount for each year cannot vary.

401( k ) PLANS

Profit sharing plans can include a 401(k) feature (also known as a cash or deferred arrangement, or CODA) under which the employees participating in the plan can choose to have a portion of their pretax compensation contributed to an individual account rather than receive the compensation in cash. These contributions are called "elective deferrals" because the employee elects to defer the receipt of the amount contributed to the account. A profit sharing plan with a 401(k) feature is popularly referred to as a "401(k) plan." A "solo 401(k) plan" is a 401(k) plan that covers only a business owner and his or her spouse.

For 2018, participants in a 401(k) plan can make elective deferrals of up to $18,500 ($24,500 for participants who are age 50 or over at the end of the calendar year). If the plan permits, employers can contribute a percentage of each employee's compensation to the employee's account (a nonelective contribution) or can, within certain limits, match the amount of employees' elective deferrals or do both. Total employer and employee contributions to a 401(k) plan are limited to the lesser of:

  • 100% of the employee's compensation, or
  • $55,000 (for 2018).

A 401(k) plan can be designed so that employees' ownership in employer matching or nonelective contributions becomes vested over time, subject to a vesting schedule. After the vesting period for a contribution is completed, the employee is 100% vested in the employer contributions and has a nonforfeitable right to the full amount of the contributions in his or her account. Providing for vesting of employer contributions to a retirement plan may help an employer retain valued employees.

Under a graded vesting schedule, an employee vests in employer contributions incrementally over a period of years. Many plans use a five - year vesting schedule, with the employee vesting in 20% of employer contributions per year of service, with the employee being 100% vested in the contributions at the beginning of year 6. For example, an employer's plan document includes a five - year vesting schedule for employer matching and nonelective contributions to employees' accounts as a plan provision. The employer makes matching employer contributions to an employee's retirement account in the amount of $10,000 in year 1. Should the employee decide to leave the company during his second year of service, he or she would be entitled to retain $2,000, or 20%, of the employer contributions.

Alternatively, some plans provide for "cliff vesting." With cliff vesting, the employee vests in all employer contributions subject to vesting after the employee meets a specific minimum number of years of service. This vesting method reduces the amount of employer contributions retained by employees in higher - turnover industries.

A 401(k) plan is more complicated for businesses to implement and administer than a SEP or SIMPLE IRA. Though, in recent years, they have become less complex and less expensive for smaller businesses, they will generally require the expertise of a third - party administrator (TPA) to maintain compliance with all funding requirements and testing of the plan. This type of plan requires an annual return to be filed with the IRS (Form 5500, Annual Return/Report of Employee Benefit Plan ) and strict compliance with regulations. Excise taxes and penalties could become substantial if the plan is not administered correctly.

Solo 401(k) or solo Roth 401(k) plans

If an owner and his or her spouse are the business's only employees, they may qualify for a solo 401(k) plan. These plans are typically offered and administered by mutual fund and insurance companies. They allow the same benefits as the plans offered by much larger companies but usually have low administrative costs.

One advantage of a solo 401(k) is that it allows self - employed individuals to obtain tremendous benefits through income deferral. Additional tax savings can be achieved if the company matches 25% of the employee's compensation. For example, an owner/employee, age 51, operates an S corporation and received a Form W - 2 , Wage and Tax Statement , with $50,000 of wages. The employee deferred the maximum allowed employee contribution of $24,500 in 2018. His business contributes 25% of his gross wages, or $12,500, on his behalf. The total amount of contributions would be $37,000, which is the maximum amount allowed.

Comparison of retirement plans for small businesses

retirement-plan-comparison

PROMPT CLIENTS TO THINK ABOUT THEIR REASONS FOR CHOOSING A RETIREMENT PLAN

To choose the right retirement plan, business owners need to weigh a variety of factors, one of the most crucial being their goals for the plan. Therefore, the first step in helping clients choose a plan is often to determine the "why" behind it: Do they desire to provide incentives to their employees? Are they seeking superstar employees and wish to compete with other companies that offer a variety of benefits? Or do business owners desire greater tax incentives and an opportunity to grow their wealth?

Your clients' answers to the "why" question can help guide their choice of plan. For example, if they want to create a sense of ownership among employees, they might consider a plan that allows profit sharing. This type of plan fosters a proprietary approach by the employees to the overall success of the company and can motivate employees to participate in the company's production and profitability.

Business owners who are interested in promoting employee retention, on the other hand, may want to select a plan that allows for the segregation of employees for funding purposes — for instance, a plan that provides greater corporate contributions for more senior employees who serve in leadership roles.

CPAs should also encourage clients to think about what their employees want and need. Too often business owners simply adopt a plan and offer it to the workforce without a true understanding as to the needs and desires of their employees. By performing a simple survey of the employees they wish to retain and/or reward, business owners may find commonalities that can help them narrow down the attributes to look for in a plan.

FACTORS TO CONSIDER WHEN SELECTING A PLAN

It is also vital for the CPA to evaluate all known factors that would impact the operation, funding, and reporting requirements of a retirement plan. Some of the most important factors include:

  • Affordability. The plan must be affordable for the company to administer and fund.
  • Who can contribute. The employee, employer, or both.
  • The number of employees and their eligibility to participate.
  • Employee turnover and vesting period. An important criterion for choosing a retirement plan is employee turnover in the business. Should the business experience a good deal of employee turnover, the company should give special consideration to the plan's vesting period.
  • Contribution limits. The minimum and maximum contribution limits for employers and employees need to be considered.
  • Administrative requirements. Another factor to discuss is how difficult the plan will be to administer. As they often have limited administrative personnel, small business owners usually seek plans and benefits that place less of a compliance burden on their human resources or payroll specialists. Many companies may select a SIMPLE IRA rather than a 401(k) because it takes less time to administer.
  • Need for a TPA. An important aspect to consider when selecting a plan is whether it will require a third - party administrator — which means that the business owner will incur an additional cost. A 401(k) plan or defined benefit plan requires TPAs that provide valuable compliance services. These more sophisticated plans must meet certain IRS regulations to maintain their favored tax status. Should a plan fail to meet the required regulations, the plan may be subject to excise taxes and penalties.
  • Operational aspects. How can contributions be made, assets managed, and information be provided to participating employees?
  • Withdrawal limits and timing. How and when can assets be accessed? What are the penalties for early withdrawal? Are there exceptions to these rules?

FINAL CONSIDERATIONS

Equipped with knowledge on myriad personal financial and tax topics, CPAs can be valuable advisers to small business owners in setting their retirement goals. They can play a vital role in assisting these clients in choosing a retirement plan that fits their personal goals as well as their business requirements.

About the author

Jimmy J. Williams ( [email protected] ) is CEO, president, and wealth manager at Compass Capital Management in Tulsa, Okla.

To comment on this article or to suggest an idea for another article, contact Courtney Vien, senior editor, at [email protected] or 919-402-4125.

AICPA resources

  • " Case Study: Advantages of a One-Person 401(k) Plan ," The Tax Adviser , Nov. 2017

Publication

  • The CPA's Guide to Financial and Estate Planning, Vol. 2 , chapter 9

CPE self-study

  • Governmental and Employer Retirement Plans (#166420, online access)

For more information or to make a purchase, go to aicpastore.com or call the Institute at 888-777-7077.

PFP Member Section and PFS credential

Membership in the Personal Financial Planning (PFP) Section provides access to specialized resources in the area of personal financial planning, including complimentary access to Broadridge Advisor. Visit the PFP Center at aicpa.org/PFP . Members with a specialization in personal financial planning may be interested in applying for the Personal Financial Specialist (PFS) credential. Information about the PFS credential is available at aicpa.org/PFS .

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Run » finance, how to set up an employee retirement plan.

Setting up a retirement plan doesn’t have to tie you up in administrative knots. A step-by-step approach will get you to a plan that benefits both your small business and your employees.

 Employee benefits don't have to be a burden to your business.

Setting up an employee retirement plan can be unnerving. The choices are many and the details can get complicated. What follows is a summary of qualified retirement plans and the steps you should take to implement them.

[Read: What You Need to Know About Qualified vs. Non-Qualified Benefit Plans ]

Payroll Deduction IRA

This is the least costly retirement plan for an employer. Administration is simple and there is no employer contribution. Payroll deductions are made using either pre-tax (Traditional) or after-tax (Roth) employee dollars. Maximum contribution for 2020 is $6,000 ($7,000 for participants over 50). To implement a Payroll Deduction IRA, taking the following steps:

  • Employee sets up IRA with a financial institution.
  • Payroll administrator is instructed to make the deductions and forward them.

Note: There are no forms for the employer to fill out.

Simplified Employee Pension (SEP) IRAs are fully funded by the employer. SEP IRAs are a good choice for businesses with just a handful of employees. Contributions are capped at $57,000 for 2020. Uniform SEP IRAs must be offered to all eligible employees . Annual contributions are not required. A SEP IRA can be set up until the due date of your business tax return for the year in which the plan will be established. Following are the steps to setting up a SEP IRA:

  • Execute a written agreement using IRS FO RM 5305-SEP . Alternately, a prototype document provided by a financial institution can be used.
  • Inform your eligible employees of the existence of the SEP IRA and specific details about it.
  • Employees must be given a copy of FORM 5305-SEP or the prototype document.

If you have less than 100 employees and no current retirement plan, you can set up a SIMPLE IRA. This plan is funded by pre-tax dollars contributed by the employee as well as funds contributed by the employer. For 2020, employee contributions are capped at $13,500 ($16,500 for those over 50). With some exceptions (new businesses, for example), employers can set up a SIMPLE IRA from January 1 to October 1. Following are the steps to setting up a SIMPLE IRA:

  • Choose a financial institution (bank, insurance company, credit union) to act as trustee, or allow your employees to choose their own.
  • Execute a written agreement. Use IRS FORM 5304-SIMPLE if each employee will choose a financial institution or 5305-SIMPLE if all employees will use the financial institution you have chosen.
  • Notify employees of their opportunity to make or change the amount of contribution and what the employer matching will be.
  • Provide a summary plan description, available from the financial institution(s).
  • Set up an individual SIMPLE IRA for each employee.

The ability to save for retirement is important to current and potential employees.

Profit-sharing plan

Any employer can set up a profit-sharing plan and contribute up to 100% of the employee’s annual salary (capped at $57,000). The decision to contribute is made from year to year, so sharing the wealth after a good year does not tie you in to doing the same in the future. Profit-sharing plans can get complex. There are regulations regarding eligibility, vesting and withdrawals. The assistance of a financial institution or benefit advisor is recommended. Steps to implementing a profit-sharing plan are as follows:

  • Determine the amount to contribute.
  • Determine how to divide the total among employees.
  • Deposit funds in a separate account for each employee.
  • File IRS FORM 550 annually.

[ Read more: Outsourcing HR: Is a PEO or ASO Right for You? ]

401(k) plans are defined contribution plans, meaning there is no set benefit promised. Money is contributed by the employee and, in most cases, the employer. No matter what form of 401(k) you choose—traditional, safe harbor or SIMPLE—you will most likely find the assistance offered by a financial institution or benefit advisor invaluable.

Professional assistance doesn’t come without a cost, and Congress recognized this when it passed the Setting Every Community Up for Retirement (SECURE) Act at the end of 2019. Among a multitude of changes to existing retirement savings regulations, the SECURE act offers a tax credit of up to $5,000 for businesses that set up new retirement plans, with an additional $500 credit for those with automatic enrollment. Following are steps to implementing 401(k) plans:

  • Research plan options. There are advantages and disadvantages as well as specific requirements for each. A benefit advisor can help sort it all out.
  • Choose a plan.
  • Arrange a trust fund to hold the assets of the fund.
  • Inform your employees.

The ability to save for retirement is important to current and potential employees. Choosing and setting up a plan to assist them is a project well worth the effort.

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Three reasons why small businesses are increasingly offering 401(k) plans

Meghan Jacobson

Alexandra Nobile

Surveying the small business retirement plan landscape

J.P. Morgan recently conducted a pulse survey to capture a quick snapshot of U.S. small business owners’ thoughts around offering retirement plans for their companies. The online survey took place between June 16 and 23 of this year and was conducted with owners of small businesses with $50,000 to $20 million in annual revenue and five to 50 employees, excluding nonprofit organizations.

Key findings:

  • A large majority of respondents—85%—are confident that their businesses will survive the current economic climate, even though the survey occurred in the midst of the COVID-19 pandemic and stay-at-home mandates across the nation.
  • Almost half of small business owners offer a retirement plan as an employee benefit, and most of those are 401(k)s ( EXHIBIT 1 ).
  • More than one-third of small business owners who do not currently offer a 401(k) plan expect to introduce one within the next 12 months ( EXHIBIT 2 ).

Retirement savings plans were the second most frequently offered employee benefit

EXHIBIT 1: EMPLOYEE BENEFITS OFFERED

what is a defined contribution plan for small businesses with fewer than 100 employees

Note: Total screened (n=590); total companies that offer a retirement savings plan (n=282). Source: J.P. Morgan Small Business Retirement Research 2020.

Many businesses that do not currently offer a 401(k) plan expect to offer one in the next 12 months

Exhibit 2: FUTURE PLANS OF OFFERING A 401(k)

what is a defined contribution plan for small businesses with fewer than 100 employees

Note: Companies not offering a 401(k) plan (n=200). Source: J.P. Morgan Small Business Retirement Research 2020.

Why are an increasing number of small business owners offering 401(k) plans?

No. 1: Small business owners feel responsible for their employees.

Survey results showed a clear trend of respondents wanting to help their employees across a range of issues ( EXHIBIT 3 ). The vast majority felt a high level of responsibility to provide health care coverage, as well as to help with employees’ overall well-being and work-life balance. Most, albeit fewer, also reported feeling responsible to help with employees’ financial wellness and retirement savings. Interestingly, significantly more small business owners who offered a retirement savings plan felt a high sense of responsibility to their employees compared with those who did not offer one (74% vs. 33%). It is important to remember that retirement savings can be a key component of financial wellness. In fact, research has found that workers are 45% more confident about their retirement when an employer offers a defined contribution plan. 1

Most feel a high level of responsibility to help employees across a range of issues

EXHIBIT 3: LEVEL OF RESPONSIBILITY FELT FOR EMPLOYEES

what is a defined contribution plan for small businesses with fewer than 100 employees

Note: Percentage responding “very high”/“some high” to the question: As an employer, which of the following best describes the level of responsibility you feel for your employees on each of the following? Total respondents (n=400). Source: J.P. Morgan Small Business Retirement Research 2020.

No. 2: They see the benefits of 401(k) plans.

Small business owners who reported offering a 401(k) plan clearly see the benefits—not just for their employees but for their businesses as well. The top reason cited for offering a 401(k) plan was to encourage employees to save for retirement. Retaining and attracting employees were the close second and third reasons, respectively (EXHIBIT 4) .

Top three reasons for offering a 401(k) plan

EXHIBIT 4: REASONS FOR OFFERING A 401(K) PLAN

what is a defined contribution plan for small businesses with fewer than 100 employees

Note: Companies offering a 401(k) plan (n=200). Source: J.P. Morgan Small Business Retirement Research 2020.

No. 3: Employees are asking for it—and employers can benefit too.

Respondents who did not offer a 401(k) cited the following top five reasons:

  • Business not generating enough revenue to offer this benefit (39%)
  • Employees don’t care/aren’t asking (28%)
  • Employees are saving in other ways (25%)
  • Other benefits are good enough (24%)
  • Administration is too costly (24%)

Cost-benefit analysis is always an important part of successful business ownership. However, research has shown that 76% of employees believe that their employers have some degree of responsibility to help them save for retirement. 2  Offering a 401(k) plan can be an easy way to help them invest in their future. Research from a recent collaboration between the Employee Benefit Research Institute and J.P. Morgan Asset Management found that 401(k)s are the only savings vehicle many Americans have, underscoring the importance of employers’ role in retirement savings.

In addition, offering a 401(k) plan may be more affordable than many small business owners might think, and costs have been trending even lower in the past several years. 3  Furthermore, companies can receive up to $5,000 per year in tax credits for the first three years after starting a 401(k) plan. 4  In fact, 31% of survey respondents noted tax deductions, credits or other tax benefits as motivators for them to offer a plan.

What small businesses are eligible for a potential 401(k) tax credit?

There are three key requirements: 5

  • The business must have no more than 100 employees who received a minimum of $5,000 in compensation from the business in the prior year.
  • The plan must cover at least one non-highly compensated employee.
  • The business did not maintain a plan covering substantially the same employees during the three years preceding the year for which the employer is claiming the credit.

Planning for the future

Our survey found small business owners largely optimistic about their companies’ outlook, with many recognizing the importance of offering a retirement plan, both for the benefit of their employees and for their businesses as well. A 401(k) plan can help acquire and retain top talent while building stronger retirement savings for employees and owners alike. In addition, advancements in 401(k) delivery have made offering employees a defined contribution retirement plan benefit more realistic and more achievable for businesses of all sizes, with less complexity and expenses than one might think.

1 Employee Benefit Research Institute (EBRI) and Greenwald & Associates, 2020 Retirement Confidence Survey. 2 J.P. Morgan Plan Participant Research, 2018. 3  401k Averages Book, 2019. 4  Internal Revenue Code Section 45E 5  Ibid.

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Qualified Retirement Plans: Big Benefits for Small Businesses

Nov 11, 2019 | Financial Planning

what is a defined contribution plan for small businesses with fewer than 100 employees

Qualified retirement plans are powerful savings tools that can help small business owners and their employees set aside assets for retirement in a tax-advantaged manner. There are many different types of retirement plans available to small businesses, and determining the most suitable type for any business should depend upon its size, its profitability, its ownership structure, and other factors. In this Navigator, we examine the most common types of small business retirement plans and discuss their suitability for various types of businesses. Not participating in some sort of a qualified retirement plan is generally a mistake, in our estimation, as business owners can use retirement plans to cut tax liabilities and improve after-tax investment returns.

Small business owners have a lot on their plates. They must make personnel decisions, marketing decisions, purchasing decisions, and the list goes on. One very important decision that may not get the attention it deserves is the type of retirement plan(s) to implement. Employer-sponsored qualified (i.e., tax-advantaged) retirement plans are highly effective savings tools, and they also play a key role in employee benefits packages. Selecting a suitable retirement plan structure is a decision that should not be taken lightly by business owners, as it could have far-reaching consequences for both owners and employees.

Before delving into specific plan types and structures, it is worth taking a moment to think about why a small business owner would want to offer his or her employees access to a qualified retirement plan. Businesses are not required to provide such benefits to their employees, and retirement plans are not without costs. However, from the perspective of the business owner, the benefits of offering a retirement plan usually outweigh the associated costs.

  • Research clearly shows that offering a retirement plan improves employee recruitment and retention.1
  • Offering retirement plan benefits allows business owners to accumulate sizable tax-advantaged savings for their own retirements.
  • Retirement plan expenses help to minimize business income taxes.

For many businesses, establishing and maintaining a qualified retirement plan is truly a win-win for both owners and employees.

With this strong case for offering retirement plans as a backdrop, let’s now examine some of the specific types of retirement plans that small businesses may choose to implement.

Small businesses can choose from several different types of qualified retirement plans. The most appropriate plan type for a specific business depends on several factors, but the size of the business is a key determinant in selecting an appropriate retirement plan type. Some plan types are more appropriate for smaller businesses or sole proprietorships, while others are more versatile and can be implemented in businesses of widely varying sizes. The table below shows the appropriateness of some popular retirement plan types for businesses of varying size.

what is a defined contribution plan for small businesses with fewer than 100 employees

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Is a SIMPLE 401(k) Plan Right For Me?

What is a simple 401(k) plan & how do you utilize it.

T he Savings Incentive Match Plan for Employees 401(k), or SIMPLE 401(k), is a simplified version of a traditional 401(k). SIMPLE plans were created so that small businesses could have a cost-efficient way to offer a retirement account to their employees.

Unlike many other workplace retirement plans, SIMPLE 401(k) plans do not require annual nondiscrimination tests to ensure that a plan is in line with IRS rules. This type of testing can be prohibitively expensive for small employers, preventing them from using other types of 401(k)s.

A SIMPLE 401(k) retirement plan is available to businesses with 100 or fewer employees including sole proprietorships, partnerships, and corporations. For small business owners or self-employed individuals, understanding how SIMPLE plans work can help decide whether it makes sense to set one up.

For employees whose employer already offers a SIMPLE 401(k), getting to know the ins and outs of the plan can help to understand the role they play in saving for retirement.

How Does a SIMPLE 401(k) Work?

A SIMPLE 401(k) functions much like a regular  401(k) . Employees contribute pre-tax money directly from their paycheck and invest that money in a handful of options offered by the plan administrator.

In 2024, the SIMPLE 401(k) limits are as follows: The maximum for employee elective deferrals is $16,000 ($15,500 in 2023); employees 50 and older could make an additional “catch-up” contribution of $3,500 to boost their savings as they neared retirement.

One significant difference between traditional 401(k) plans and SIMPLE 401(k) plans is that while employer contributions are optional with a 401(k) plan, under a SIMPLE 401(k) plan they are mandatory and clearly defined. Employers must make either a  matching contribution  of up to 3% of each employee’s pay or make a nonelective contribution (independent of any employee contributions) of 2% of each eligible employee’s pay. The contribution must be the same for all plan participants: For example, an employer couldn’t offer himself a 3% match while offering his employees a 2% nonelective contribution.

There are other limits on how much an employer can contribute. The maximum compensation that could be used to figure out employer contributions and benefits is $345,000 for 2024 ($330,000 for 2023). So if an employer offered a 2% nonelective contribution and an employee made $355,000 a year, the maximum contribution the employer could make would be 2% of $345,000, or $6,900.

As with a regular 401(k), contributions to a SIMPLE plan grow tax-deferred — meaning an employee contributes pre-tax dollars to their plan, and doesn’t pay income tax on that money until they withdraw funds upon retirement. Typically, the tax-deferred growth means that there is more money subject to compounding interest, the returns investments earn on their returns.

Withdrawals made during retirement are subject to income tax.

(Learn more:  Personal Loan Calculator ) 

Who Is Eligible for a SIMPLE 401(k)?

To be eligible for a SIMPLE 401(k), employers must have 100 or fewer employees. They cannot already offer these employees another retirement plan, and must offer the plan to all employees 21 years and older.

Employers must also file Form 5500 every year if they establish a plan.

For employees to be eligible, they must have received at least $5,000 in compensation from their employer in the previous calendar year. Employers cannot require that employees complete more than one year of service to qualify for the SIMPLE plan.

A SIMPLE IRA is also one of a number of  retirement options for the self-employed .

What Are the Pros of a SIMPLE 401(k) Plan?

SIMPLE 401(k)s offer a number of benefits that make them attractive to employers and employees.

  • Simplified rules: While large companies may have the money and staff to devote to nondiscrimination testing, smaller companies may not have the same resources. SIMPLE 401(k)s do not have these compliance rules, making them more accessible for small employers. What’s more, the straightforward benefit formula is easy for employers to administer.
  •  “Free money”: Employees are guaranteed employer contributions to their retirement account, whether via 3% matching contributions or 2% nonelective contributions.
  • Fully-vested contributions: All contributions — those made by employees and their employers — are fully vested immediately. Employees who qualify for distributions can take money out whenever they need it. While this can be good news for employees, for employers it removes the option to incentivize workers to stay in their job longer by having their contributions vest several years into their tenure with the company.
  • Loans and hardship withdrawals: While withdrawals made before age 59 ½ are subject to tax and a possible 10% early withdrawal penalty, employees can take out loans against their SIMPLE 401(k) just as they can with a traditional 401(k). These options add flexibility for individuals who need money in an emergency. It’s important to note that  401(k) loans  come with strict rules for paying them back. Failing to follow these rules may result in penalties.

What Are the Cons of a SIMPLE 401(k) Plan?

While there are plenty of positives that come from offering or contributing to a SIMPLE 401(k), there are also some important downsides.

  • Plan limitations: Employers cannot offer employees covered by a SIMPLE 401(k) another retirement plan.
  • Lower contribution limits: For 2024, a traditional 401(k) plan allows for $23,000 annual  maximum 401(k) contributions  from employees, with an additional $7,500 catch-up contribution for those 50 and older. These contribution limits are considerably higher than SIMPLE plan limits, which in 2024 are $16,000 with an additional “catch-up” contribution of $3,500 for employees over age 50. This means an employee could potentially contribute an additional $7,000 in elective deferrals and $4,000 in  catch-up contributions with a traditional 401(k)  rather than a SIMPLE 401(k).
  • Limited size: SIMPLE Plans are only available to employers with fewer than 100 employees. That means if a business grows beyond that point, they have a two-year grace period to switch from their SIMPLE plan to another option.

SIMPLE 401(k) vs SIMPLE IRA

Generally speaking, when comparing  SIMPLE IRAs  and SIMPLE 401(k)s, the rules are similar:

  • They’re only available to businesses with 100 or fewer employees.
  • Employers must either offer a 3% matching contribution or a 2% nonelective contribution.
  • Employers can only make contributions on up to $345,000 in employee compensation in 2024.
  • Employee contribution limits to SIMPLE IRAs are the same as their 401(k) counterparts.
  • Employer and employee contributions are fully vested immediately.

There are a few differences worth mentioning:

  • Whereas all employer contributions are subject to the cap for SIMPLE 401(k)s, only nonelective contributions are subject to the $345,000 compensation cap for SIMPLE IRAs. (This makes it possible that employees making more than $345,000 annually may receive higher matching contributions from a SIMPLE IRA than they would from a SIMPLE 401(k).)
  • If employers make matching contributions of 3%, they may elect to limit their contribution to no less than 1% for two out of every five years.
  • SIMPLE IRAs do not allow employees to take out loans from their account for any reason.
  • There are no minimum age requirements for SIMPLE IRA contributions.

The Takeaway

SIMPLE 401(k) plans can be especially attractive for self-employed individuals or small business owners, as they have many of the same benefits of a traditional 401(k) plan — including tax-deferred contributions and loan options — but without the administrative compliance costs that come with a regular 401(k) plan.

SIMPLE 401(k) plans can be especially attractive for self-employed individuals or small business owners.

Some of the requirements and rules associated with a SIMPLE 401(k) plan might be unattractive to some employers, however, including the fact that the IRS prohibits employers from offering other types of retirement plans to employees who are covered by a SIMPLE 401(k).

There are many answers to the question of  which retirement savings plan is right for you  or your business. Beyond traditional 401(k) and SIMPLE (401)k plans, there are traditional, Roth, SIMPLE and SEP IRAs, among other options.

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

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