Is setting up an independent 401(k) plan always better than an IRA for a small business?
When setting up a small business with only a few partners and employees, is it better to set up independent 401(k) plans for everyone or should they each open an IRA account suitable for their situations? If the 401(k) option is best, what kind of plan should be chosen or offered? If IRA's, Roth or Traditional? How can you set these up so that they are immediately available for contributions to be made?
It really depends upon how much everyone plans to contribute & if the company plans to match. If you are looking to put in more than the IRA limits of $5,500 or $6,500 if 50 or older then the 401k is a better option because an employee can withhold up to $18,000 or $24,000 if 50 or older with the catch-up provision. Plus if the company (the owners) so choose, they can add a matching element. This could vary to somewhere around a 3%+ match all the way up to a Profit Sharing where you could put in much more up to $54,000 or $60,000 if 50 or older based upon a percentage of salary. If you have only a few non-owner employees, this becomes very attractive.
So again, it depends upon what you are trying to accomplish. IRAs are simpler but much less flexible regarding contributions. Regarding Roth versus before tax, you can still offer either components if you like. Really depends upon whether you want to pay the tax now for potential future tax-free income or tax the deduction now. Generally, the younger you are and the lower your tax rate, the more a Roth IRA or Roth 401k becomes. This is because the tax deduction isn't as valuable and you have more time to compound inside the retirement plan.
Hope this helps and best of luck, Dan Stewart CFA®
Great question and one asked by many businesses!
In most cases a 401(k) is not a great solution. It can work very well if all the people within the company are owners and their family members. In this instance you can set up an Individual or Solo (k) and avoid much of the expense associated with a 401(k) Plan.
Shoudld you not be in a position to set up a solo or individual (k) because some of the employees are not owners or their immediate family, then i would look to a SIMPLE IRA. There are pro's and cons to this typ of plan and you read about the plan here: SIMPLE IRA Tutorial
IRA and Roth's are typically not set up by companies, these are not corporate plans. Based upon your question I do no think these would assist you in reaching your goals.
I highly recommend you review the two options above and see which is best suited for you and you company. Best of luck in navigating this decision.
The short answer is no, a 401k is not always better than an IRA. Typically, there are two reasons to invest in a 401k rather than an IRA, as an employee: 1) there is a match available in your 401k, 2) you are already maxing out your IRA, and would like to save more on top of that.
The maximum IRA contribution is $5,500/year per person ($6,500/year if you are over 50). Keep in mind that you can contribute to an IRA for a non-working spouse, making your potential household contribution $11,000.
If you or the other employees/partners are interested in saving more than this, a 401k is a good option. Historically, 401k plans were only available to large companies who could afford them. However, over the course of the last couple of years, plans have come available that are affordable for companies with as few as one employee.
Aside from being able to contribute up to $18,000 a year, NOT including employer contributions, 401k plans are greatly customizable, in terms of what features you want to offer (vesting, matching, profit sharing, Roth/Traditiona, etc.).
In either case (IRA/401k), the Roth vs Traditional decision involves a consideration of a number of factors. Generally, a Roth can be more advantageous in the long run, as the full balance of the account (including earnings) can be withdrawn tax-free, unlike Traditional IRA/401k Savings which will be taxed to the retiree as regular income. Additionally, Roth assets will not have RMDs (required minimum distributions). The downside to the Roth option is that you do not receive a tax deduction upon contribution.
The best retirement plan for your business will depend on how many employees and how much you want to contribute. You can offer a 401k with both ROTH and Regular contribution allowed. You should be able to make contribution shortly after setting up the plan. Your employees can choose which investment and whether to invest in a ROTH or Regalar 401k.
If you want to choose the best account for your business check out this post:
Live for Today, Plan for Tomorrow.
DAVID RAE, CFP®, AIF® is a Los Angeles-based retirement planning specialist with DRM Wealth Management. He has been helping small business owners reach their financial freedom for over a decade. He is a regular contributor to the Advocate Magazine, Investopedia and Huffington Post as well as the author of the Financial Planner Los Angeles Blog. Follow him on Facebook, or via his website www.davidraefp.com
For small businesses with less than 100 employees/partners, I normally suggest a SIMPLE IRA over a 401k. 401ks are very expensive to administer, and there are many cooks in the kitchen.
A SIMPLE IRA on the other hand, is simple (although it stands for Savings Incentive Match PLan for Employers).
If any of the participants want to save more than the allowed $5,500 ($6,500 if over age 50) in a Traditional or Roth IRA, then a SIMPLE would be the first plan to consider. Any participant can save up to $12,500 in their SIMPLE IRA.
One downside to the SIMPLE IRA is that the empoyer is required to match up to 3% of each employee's contributions. Although for a small business, that's usually good incentive for people to save for retirement. Who doesn't like free money?
Another downside (from an employer perspective) is that the SIMPLE IRA matching is vested immediately. In a 401k, you can design the matching contributions to vest over time, holding your employees hostage in a way. I actually prefer immediate vesting, for simplicity and as good faith compensation.
So to recap:
1. If the employer does not want to contribute to employee accounts, a Traditional or Roth IRA is the way to go. Each employee can contribute up to $5,500/$6,500 per year in their own accounts.
2. If any employee hopes to save more than $5,500/year, the SIMPLE IRA is the plan to consider, as it allows contributions up to $12,500.
3. If you want a vesting schedule for employer matches, or if employees want to save more than $12,500/year, you need to consider a 401k (which allows contributions up to $18,000/year).
I hope that helps!