- Staying with SIMPLE plans.
SIMPLE plans are a relic of the 1990’s. You can consider them the poor man’s 401(k). They allow for employee salary deferrals and have an employer matching component, but they come from an era when real 401(k) plans were expensive to setup and maintain.
That’s no longer the case. Even the smallest companies can afford a “Safe Harbor” 401(k) plan. These plans allow for a larger employee contribution (for the owner as well) and a more flexible employer match. These plans are a necessity in a tight labor market to retain employees against competition from larger firms.
- Not considering solo 401(k) plans for sole proprietors.
Many sole proprietors believe the only plan available to the smallest of companies is the SEP / IRA pension plan. The SEP is basically an IRA on steroids. The SEP allows for a much larger contribution than an IRA, but is limited to 25% of profit. If the business profit isn’t much, the SEP pension contribution is very high either. In some cases, a regular IRA yields a bigger deduction.
A solo 401(k) plan has two components just like a regular 401(k) plan. There is an “employee” salary deferral, even for a sole proprietor. There is also an employer match. Solo 401(k)’s are available to a business owner and spouse. Beyond that, a safe harbor 401(k) is the best choice in most situations.
The solo 401(k) almost always allows for a larger pension contribution than an SEP even at relatively low levels of profit.
- Not evolving your pension plan as your business evolves.
The right pension plan for your business when you’re just starting out is rarely the right choice for your business as you grow and add employees. And even that next plan may not be the right one as you near retirement.
An SEP might be a perfectly fine plan for a small startup business with few employees that wants a pension plan, but has little money to contribute. However, as that business grows and needs to retain employees, as well as provide a better retirement plan for the owners, a safe harbor 401(k) might be a better choice. As an entrepreneur winds down towards retirement, choosing a pension plan with age weighting may become important.
Another example of company evolution resulting in bad pension choices is a sole proprietor electing S corporation status, but sticking with an SEP plan. SEP plan contributions are based on salary. In the new S corporation, the owner might be taking just a small salary resulting in a smaller SEP contribution than he or she received as a sole proprietor. Switching to a type of 401(k) plan is usually a great idea.
Planning your pension choices as your business evolves is the key to a comfortable retirement and happy employees.
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