|401k||SIMPLE IRA||SEP IRA|
|Who can contribute||Employee; employer optional||Employee & Employer||Employer only; must make uniform contributions on behalf of all eligible employees|
|Maximum employee contribution||$22,500 plus $7,500 catch up if over 50||$12,500 plus $3,000 catch up if over 50||NA|
|Employer contribution||Up to 25% of earnings capped at $66k ($73.5K if over 50) including profit sharing option||Must match 100% of first 3% of participating employee contributions or 2% of all eligible employee salaries||Employer-only contribution up to 25% of income or compensation with a $53K cap|
|Access to funds before 59½||Participant may take penalty-free loans; 10% penalty for early withdrawal||25% penalty for withdrawals within first two years of plan; 10% thereafter||10% penalty for early withdrawal|
|Vesting||Can have vested schedules that are long as 6 years on employer contributions||Participants are 100% Vested on all contributions||Participants are 100% Vested on all contributions|
To illustrate, Sally, age 51, is taxed as a corporation with W-2 wages of $70,000. Looking for a plan that allows the highest contribution limit, she compares the options:
|Plan Option||Employee Salary Deferral||Employer Contribution||Total Contribution|
The biggest advantage, as shown here, is that the individual 401k plan allows for both an employee and employer contribution. In addition, Sally would enjoy the following key advantages:
- If her spouse, Sam, age 49 is employed at the company and had W-2 wages of $40,000, they can add his salary deferral up to $18,000 and make a profit-sharing contribution of $10,000 putting a combined total at $64,000 in the plan.
- If he chose to do so, he could employ the Roth 401k option, which has no income restrictions, for his salary deferral contribution. His contribution would not be pre-tax, but he would be able to withdraw funds tax free.
Finally, the employer has flexibility to design, modify, or even terminate a 401k plan. Unlike a SEP IRA or SIMPLE IRA, which use fixed, standard contribution formulas and eligibility requirements, a 401k plan sponsor can adjust contribution formulas and eligibility requirements to suit their particular needs or profit situation. In addition, SEPs and SIMPLEs can only be terminated at the end of the calendar year, whereas a 401k plan can be terminated at any time. 401k plans afford additional benefits for employers who seek the greatest amount of flexibility in their retirement plan.
For self-employed business owners, the 401k plan offers the highest contribution limits, much more flexibility in designing their plan for optimal tax advantages. The added benefit of penalty-free access via loans in the event of the unexpected provides even greater flexibility over the other plan types.
As always, it is strongly recommended that you consult with a qualified plan expert to thoroughly assess your needs and circumstances when selecting a retirement plan for your business, especially if you anticipate hiring new employees.Read other small business financial articles