First Person: 4 Types of Small Business Retirement Plans

Small businesses can attract and retain valuable employees by offering tax-deferred retirement plans. One of the major advantages of small business retirement plans is that the contributions made on behalf of the business owner or his/her employees can be deducted as business expenses.

Almost anyone who earns self-employment income can qualify for a small business retirement plan, from independent consultants and contractors to store owners and real estate agents. Individuals who have home-based businesses are also eligible. Small business retirement plans can also be established for individuals who earn only part of their income from their side business while continuing to work for someone else.

There are 4 small business retirement plans: Individual 401(k), SEP IRA, SIMPLE IRA and the Profit Sharing Plan.

Individual 401(k)

An individual 401(k) plan allows business owners and their spouses to make contributions into either a tax-deferred retirement account or a Roth 401(k) plan (or both). The contributions can come from the employee's base salary and the company's profits. If only the employee's base salary is used, up to $16,500 can be contributed for 2010 (or $22,000 for those over age 50). If a company contribution is made, the contribution can be as much as 25% of the owner's base income (if the business is incorporated or the owner receives a W-2) or 20% if the business owner is a sole proprietor and has filed a schedule C. Combined salary and company contributions can total up to $49,000 (or $54,500 for those over age 50) for 2010.

Small businesses that have employees other than the business owner and his/her spouse do not qualify for the Individual 401(k).

SEP IRA

A SEP IRA is much like a Traditional IRA except that its contribution limit is higher. For 2010, the SEP IRA contribution limit was 25% of income (20% for sole proprietors who had filed a Schedule C) or $49,000. Contributions are not mandatory for every year; however, if they are made, the same percentage must also be set aside for the SEP IRA accounts of eligible employees.

Employees can be required to satisfy certain age and work history requirements before contributions are made to their SEP IRA accounts. For example, employees can be required to be a minimum of 21 years of age and to have worked three of the past five years at the small business. Once those requirements are satisfied, however, the business owner is obligated to contribute the same amount of money to employee SEP IRA accounts as to his/her own SEP IRA account.

SIMPLE IRA

The SIMPLE IRA is available to small businesses that employ fewer than 100 employees and allows both the employer and employee to contribute to the employee's retirement plan. For 2010, employees could defer as much as $11,500 of their earnings($14,000 if over age 50). The employer then matches up to 3% of those employee income deferrals. Alternately, a 2% non-elective contribution can be made for all employees regardless of whether they participate in the plan or not. One disadvantage of the SIMPLE IRA is that employees need not be vested in the plan and therefore can keep the money even if employed for only a short period of time.

Profit Sharing

The profit sharing plan imposes the same contribution limits as the SEP IRA and allows for vesting before employees are entitled to employer contributions. Vesting can be specified as a given amount of years that are invested in the company. Alternately, the employer can require that employees put in a given number of service hours per year before they become eligible to make contributions. By imposing a requirement on hours, temporary, seasonal or part-time employees can often become excluded from profit sharing. Finally, a profit sharing plan permits loans on up to 50% of the vested balance.