As a small business owner, you might be confused by all the different small business retirement plan options out there. One retirement option you can offer is an individual retirement arrangement, or account (IRA). There are several types of IRA accounts you could consider.
Different types of IRA accounts
An individual retirement arrangement is an account you or your employees can contribute funds to for the purpose of retirement. There are several types of IRAs you might consider offering to your employees:
- Traditional IRA
- SEP IRA
- SIMPLE IRA
- Roth IRA
If you decide to create an IRA for yourself or your employees, there are a few ways you can get started. The IRS says you can start an IRA with a bank, life insurance company, mutual fund, or stockbroker. Let’s examine how each of the IRA types work.
With traditional IRAs, you (the employer) do not contribute to your employees’ accounts. However, you can establish your own IRA account and contribute to it. Your employees are required to open their own IRAs if they want to start a retirement fund.
Traditional IRA plans can be combined with other retirement plans. For example, an employee can contribute to their traditional IRA plan even if they have a Roth IRA plan. And, a traditional IRA plan can be part of a SEP plan.
You must pay fees to the trustee and brokers’ commissions where you open the plan. Since these are individual accounts, the fees might be deductible on individual tax returns. When you file Form 1040, U.S. Individual Income Tax Return, attach Schedule A, Itemized Deductions.
Since you or your employees open an individual traditional IRA account, there is no requirement as far as your business is concerned. If your employee wants to establish a traditional IRA account, you can provide information to them and withhold money from their wages for the account. However, the individual must meet the following requirements to open a traditional IRA:
- Received taxable compensation during the year
- Are not age 70.5 by the end of the year
If you or your employees have traditional IRA plans, there are no contribution requirements. This is an individual plan that an individual can elect to contribute to. An individual is not required to contribute every year.
Employees who are a certain age or older can choose to contribute more than the contribution limit, which is known as a catch-up contribution. The catch-up contribution lets the individual contribute additional funds to their retirement plan.
Under a traditional IRA plan, the individual cannot contribute more than the lesser of (2023):
- $6,500 ($7,500 for individuals age 50 or older)
- Taxable compensation
Fees paid to the institution where the individual opened the IRA are not included in the contribution limit.
For more information on traditional IRAs, visit the IRS website.
A Simplified Employee Pension (SEP) plan is one type of IRA account you can choose to establish at your small business. With a SEP plan, you are the only person contributing to each employee’s retirement fund. Employees do not contribute. You can also contribute to your own SEP plan.
Contributions to a SEP plan are tax deductible. For the first three years of the plan, you might be eligible for a tax credit of up to $500 per year.
If you decide to set up a SEP, you do not need to pay start-up and operating costs. Take a look at some of the SEP requirements.
If you establish a SEP plan at your business, you must enroll each eligible employee in the plan. In order to be considered eligible, an employee must meet the following criteria:
- Age 21 or older
- Worked for you at least three of the last five years
- Received at least $750 in compensation (for 2023)
With a SEP plan, you are the only person contributing. The amount you contribute can change each year. And, you are not required to contribute anything. The plan is great for a business with fluctuating cash flow. For years you do not have as much extra cash on hand, you do not need to contribute.
There are limits on how much you can contribute to each employee’s retirement plan. According to the IRS, you must not exceed the lesser of:
- 25% of the employee’s compensation
- $66,000 for 2023
In some retirement plans, employees who are a certain age can choose to contribute more than the contribution limit, which is known as a catch-up contribution. Since employees do not contribute to a SEP plan, there is no catch-up contribution option.
To establish a SEP plan for your small business, you must complete and sign Form 5305-SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement.
You will then give your employees a copy of the filed Form 5305-SEP. In most cases, you are not required to file annual reports with the IRS. The organization you organize the SEP through gives the IRS annual statements.
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A SIMPLE, or Savings Incentive Match Plan for Employees, IRA lets both you and your employees contribute to an employee’s retirement fund. Like a SEP plan, SIMPLE plans are easy for small businesses to manage.
You might be eligible for a tax credit of up to $500 per year for the first three years of your plan. Take a look at the following information on SIMPLE IRA plans.
In order to establish a SIMPLE plan, your business must have 100 or fewer employees. You cannot have an additional retirement plan if you have a SIMPLE plan at your business. Eligible employees are those who received at least $5,000 each year during the two years before it’s established.
There is a two-year grace period to change your plan if your business grows and exceeds the 100-employee limit. You must have had the plan for at least one year in order to qualify for the grace period.
With a SIMPLE plan, you can either match your employees’ contributions or contribute to each employee’s account, regardless of if they contribute.
Employee contributions to a SIMPLE IRA are pre-tax deductions. The contributions lower their federal income tax liability.
Employees cannot contribute more than $15,500 to their SIMPLE plan in 2023. However, if the employee is 50 or older, they are allowed an additional catch-up contribution of $3,500 in 2023. That would bring the contribution limit to $19,000 for an employee age 50 or older.
For your contributions, you can select one of three options: matching, lower percentage, or non-elective contributions. Take a look at your options:
- Matching Contributions: You must match the employee’s salary reduction contributions at a rate of 3% of the employee’s compensation.
- Lower Percentage Contributions: If you want to match your employees’ contributions at a rate less than 3%, the percentage must be at least 1%. You cannot contribute less than 3% for more than two out of five years.
- Non-elective Contributions: You contribute to each employee’s account, regardless of if they contribute or not. You must contribute at a rate of 2% of compensation (up to $330,000 for 2023).
To establish a SIMPLE plan, you must file one of the following forms:
- Form 5304-SIMPLE (if employees get to choose the financial institution that receives the contributions)
- Form 5305-SIMPLE (if employees do not get to choose the financial institution)
After filing the form, you must notify your employees of the newly established plan. You do not need to file an annual report with a SIMPLE plan.
Like a traditional IRA, a Roth IRA is an individual account you or your employees can contribute to. What’s the main difference between traditional and Roth ira accounts? With a Roth IRA, the contributing individual cannot deduct contributions on tax returns.
In order to contribute to a Roth IRA account, you must meet certain income requirements. Your modified AGI (adjusted gross income) must be less than the following to contribute:
- Single: $153,000
- Married filing jointly: $228,000
Your modified AGI is your total gross income minus deductions and plus tax-exempt interest. For more information on contribution requirements to a Roth IRA, visit the IRS website.
The contribution limit to a Roth IRA plan is the lesser of the following:
- $6,500 ($7,500 if you are age 50 or older)
- Taxable compensation
|Employee Requirements||Contribution Requirements||Contribution Limit||Filing Requirements|
|Traditional IRA||None; individual account||None||Under age 50: $6,500|
Age 50 or older: $7,500
|SEP IRA||Each eligible employee must be enrolled||None, but the employer is the only one contributing||Employer can’t exceed the lesser of 25% of employee’s compensation or $66,000||Form 5305-SEP to establish plan; give each employee a copy|
|SIMPLE IRA||Must have 100 or fewer employees||Employer can match employees’ contributions at a rate of 3% or contribute to each employee’s account at a rate of 2%||Under age 50: $15,500|
Age 50 or older: $19,000
|Form 5304-SIMPLE or Form 5305-SIMPLE|
|Roth IRA||None; individual account||AGI must be less than $153,000 (single) or $228,000 (married filing jointly)||Under age 50: $6,500|
Age 50 or older: $7,500
Want to make contributions to employee IRA plans easier? You can withhold contribution amounts from employee wages with Patriot’s online payroll software. Try it for free today!
This article has been updated from its original publish date of March 14, 2012.This is not intended as legal advice; for more information, please click here.