A Business Owner's Guide to Choosing the Best Retirement Plan for Employees

By Richard Tatum

Did you know that finances are a leading cause of stress for Americans? And since most people’s first—and often only—form of retirement savings comes from their workplace, many employers view it as their obligation to help employees prepare for their futures. Not to mention that stressed employees directly translate to lost revenue for your business.

But there’s good news. There are many benefits to providing a company-sponsored retirement plan (for both you and your employees), and offering a plan is actually less expensive and time consuming than you might think. New technology has made offering a retirement plan easier than ever, helping you save time and money while also setting your employees up for success.

There are many different options for retirement plans, which can sometimes get confusing. This guide will help you understand the benefits and limitations of each plan so you can make the best possible decision for you and your employees.

Types of retirement plans

401(k) plan

Perhaps the most widely known form of retirement plan, 401(k) plans are available to most private organizations, including sole proprietorships, S and C corporations, and partnerships.

Benefits: 401(k) plans offer flexibility in both plan design and features. Loans and hardship withdrawals are permitted and employees can contribute more on a pre-tax basis (up to $19,500, plus an additional $6,500 for participants over age 50 for 2021). Another perk is employers can offer to match a portion of their employee’s compensation, both as a benefit as well as an incentive to engage their employees with the program. Tax credits are significant, and if you choose to match your employees’ contributions, you’ll also receive a substantial tax deduction. Business owners can also reduce their personal taxable income as well.

Limitations: 401(k) plans must be tested for compliance with a wide array of internal revenue code and other requirements, and those tests can be expensive. They must also file an annual return, called a Form 5500, which can be costly and time consuming to prepare. Your financial advisor should be able to help with those tests, limiting the time investment on your end.

403(b) plan

Similar to a 401(k), 403(b)s are retirement plans for nonprofit organizations and certain kinds of public entities.

Benefits: All employees are immediately eligible to participate. Like the 401(k), employers can also match contributions and employees can set aside up to $19,500 in 2021, plus an extra $6,500 for those 50 and older.

Limitations: Similar to 401(k)s, there is rigorous testing involved as well as the required Form 5500.

Savings Incentive Match Plan for Employees (SIMPLE) IRA

SIMPLE IRAs are only available to businesses with 100 or fewer employees who earn more than $5,000 per year.

Benefits: True to its name, SIMPLE IRAs are easier to create and maintain, as well as less expensive than many other options.

Limitations: Employers must contribute to employee retirement accounts, so these plans may not be appropriate for all businesses. In addition, employee withdrawals taken within the first two years will incur a 25% tax penalty (35% if the employee is under age 59-1/2).

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Simplified Employee Pension (SEP)

A SEP plan provides business owners with an easy way to contribute toward their employees’ IRAs. These plans are available to any employer, including sole proprietorships, S and C corporations, partnerships, nonprofit organizations, and government entities.

Benefits: SEPs are easy and relatively inexpensive to create and allow employers to offer a retirement benefit to employees of up to 25% of the employee's compensation (subject to certain limits). All contributions are immediately 100% vested (which means employees receive all contributions, regardless of how long they work at the firm).

Limitations: Employees cannot contribute to their savings, only the employer can, and those contributions are mandatory. Some businesses may find these plans cost prohibitive.

Individual Retirement Accounts (IRAs)

IRAs are widely available, but as the name suggests, they are sold directly to investors and not offered as part of a traditional employee benefit plan. We include them on this list because they can become part of an employee retirement strategy, used in tandem with one of the other options above.

Additionally, state legislation is now requiring that employers in certain states offer company-sponsored retirement plans, many of which are offering state-run payroll-deducted IRAs, as a way to improve access.

Benefits: These plans are easy and relatively inexpensive to set up, and generally have low annual fees. State plans, in fact, are at no cost to the employer and typically have nominal employee fees.

Limitations: Account holders can only put away $6,000 per year on a pre-tax basis—less than a third of what a 401(k) plan allows—so highly compensated individuals may not receive any tax benefits. Also, the broker, or state, that sold the IRA does not owe any fiduciary duty (unlike in a 401(k) or other employee benefit plan), so it's difficult to know whether participants are really getting the lowest fees available or if the investments are best suited to meet their needs. Finally, IRAs do not permit account holders to withdraw funds until reaching retirement age, so if an emergency arises, there is no ability to obtain a loan or withdrawal from the account without facing stiff tax penalties.

Choosing the best retirement plan option

So how do you choose the best retirement plan for employees and your company? There are many factors that go into making that decision, including the size of your company, number of employees, and annual revenue. We recommend working with a financial advisor to identify the motivating factors behind implementing a plan. By assessing your intended outcome alongside the structural makeup of your organization, you’ll have better insight into the best fit for you.

And the good news is, regardless of which route you take, your employees will thank you—whether now or some time around the time they turn 65!

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