First Steps for Small Business Owners Starting a Retirement Plan

The first questions small business owners must ask before selecting the best retirement plan for their business.

Black shoes standing at start here line

Retirement plans provide many benefits to small business owners and employees. You may have heard of popular plans like 401(k)s but there are many more choices for small business owners. How do you choose between them?

Picking the best plan for you as a small business owner and for your employees involves three major steps:

  1. Clarify your goals for the retirement plan.
  2. Choose the retirement plan benefits that support your goals.
  3. Pick your plan.

I’ll now walk you three each of these steps.

Step One: Clarify Your Goals for the Retirement Plan

Here are some popular reasons you may want your small business to offer a retirement plan:

Tax benefits for the employees and the business

This is often one of the biggest retirement plan benefits to small business owners. If you currently have a high income, you pay a high tax rate on that income. A retirement plan can allow the income taxes on your compensation to be deferred until the future when you may be in a lower tax bracket. You pay taxes on that compensation and investment earnings on that compensation when you withdraw them. However, other plans allow you to pay taxes now but future withdrawals are exempt from taxes. A small business may also qualify for a tax credit for setting up certain plans.

Retain or recruit employees

You are competing for top talent against businesses of all sizes. Larger companies often provide retirement benefits to their employees. These large employers also have other benefits that would be very hard for you to provide. A retirement plan can help improve your odds of winning the battle for talent against these large companies. Many small business owners think a retirement plan is too expensive or difficult for their business. On the other hand, the cost of the plan may be lower than the high costs of employee turnover, inability to recruit top talent, and higher taxes.

Provide for the future of all your employees

Some retirement plan options allow a high amount of benefits to key employees but other plans provide equal benefits to a broader set of employees. Retirement plans provide an incentive for your employees to save for the future. These savings provide a stronger foundation for their financial future.

Send a message to your staff about how much you value them

Current and potential employees may see the lack of a retirement plan option as a cue that the employer doesn’t fully value its staff. The lack of a plan may send a negative message about the company’s culture. A retirement plan is another way for you to show your appreciation for your employees.

Protect assets from creditors

Retirement plans have very strong protection from creditors. This is highly beneficial for medical professionals and other business owners that work in industries that are prone to lawsuits. Funds may also be protected from bankruptcy creditors. Business owners often put much of the net worth at risk through their companies so this is a way to receive strong protection for funds you will need in the future.

Incent employees to increase the company profits

Some owners may want to align the incentives of the employees with the profit incentive of the owners. In this case, plans can be set up to provide higher benefits to employees when the company has higher profits. Employees may be more focused on how to make the company more profitable if they know they can share in some of those profits.

Step Two: Choose the Small Business Retirement Plan Benefits that Meet Your Goals

People gathered around the checkboxes connected by lines.

Step one identified your big goals for the plan. Now you need to start thinking through how you as the owner want to use the plan and how the employees will use the plan. Your thoughts about the plan’s goals help inform your answers to the questions below. It’s likely that there is no perfect retirement plan for all your goals so you will need to find a plan that meets your highest priorities.

Here are some key questions to consider:

How much time and money do I have to set up and manage a retirement plan?

This may be one of your biggest concerns. You will need to cover the cost of the benefits you provide as well as the costs of setting up and maintaining the plan. The more complicated the plan, the more you will pay for plan administration. However, these fees may be well worth the investment so you can provide a valuable benefit for yourself and your employees. You want to hire retirement plan experts so you don’t waste time, violate laws, and miss opportunities by trying to manage the plan yourself. Retirement plan providers take on the vast majority of the work of running a plan.

Should the plan maximize flexibility or simplicity?

You may need to make trade-offs between the two. Think about this from both an employer perspective and an employee perspective. A flexible plan with many choices may be more complicated and come with higher administration costs. On the other hand, it will also require more explanation for employees to understand it. Some employees like flexibility and options while others need something simple.

Who makes the contributions: The company? The employee? Both?

Some employers create a plan and let the employees decide whether contributing to it is a high priority. Other employers may want to contribute to the plan rather than providing other types of compensation. Employees may not appreciate the future benefits of a retirement plan or have little discretionary income to defer into the plan. Small business owners concerned about these employees may want to contribute to the plan.

How much do I as the small business owner want to save through a tax-advantaged plan?

Some plans allow you to put more money into the plan than other options. Working with your personal financial planner or a tax expert will help clarify this.

Will a few highly compensated individuals contribute a high proportion of plan contributions?

Some plans require “nondiscrimination testing.” This testing compares the contributions of the highest earners to the contributions of all other employees. These plans don’t allow the high earners to have contribution rates that far exceed the contribution rates of all other employees. Nondiscrimination testing set a cap on the contribution rates of these higher earners.

How much would my employees want to contribute to the plan?

Employees may want a small business retirement plan that allows them to contribute larger amounts than what they can contribute to their personal investment retirement accounts (IRAs). If you have employees like this, they would value plans that allow higher employee contribution amounts.

Should contributions be immediately vested by the employee or do I want this vesting to occur over time to promote employee retention?

An employee is “vested” in their funds when they “own” the funds. If they leave the company, any non-vested employer contributions can be used as part of the contributions you will owe to other employees. The key consideration here is employee retention. Your contribution costs will be lower with longer vesting schedules. This is especially true if you have a high employee turnover rate. On the other hand, your employees and potential recruits may place a high value in being able to vest earlier.

Which employees do I want to be eligible to join the plan?

Some plans require benefits for employees at least 21 years old who have worked 1,000 hours in the past year. Some plans allow tighter eligibility requirements. Of course, you’re always able to be more generous than these minimums.

Roth IRA vs Traditional IRA
Roth IRA vs Traditional IRA written in the notepad.

What funds do I want to be tax deductible: the contributions, the funds when they are withdrawn, or both?

It used to be that contributions to most plans were tax-deductible and you were taxed on the funds and earnings on those funds when you withdrew them. Then along came the Roth plans. Roth plans allow contributions of after-tax dollars but all fund withdrawals (both contributions and earnings on those contributions) are tax-free if you follow the Roth rules. Roth plans are generally more tax advantageous for younger workers who are currently in a low tax bracket and have a long time until they need to withdraw the funds. Some plans allow both traditional (i.e. pre-tax or tax-deferred) and Roth (i.e. after-tax) contributions.

How much will my company change over the next 5 years? Will we have large increases in staff?

You don’t want to have to change plans a few years after setting this up. Think through the likely growth trajectory of your company and select the plan that works for you today and for your vision of your future.

Step Three: Pick a Small Business Retirement Plan

You know your goal for the plan and have prioritized benefits options for your plan. Now you’re ready to look at different types of plans that are available. There are many choices. I’ll give you a very high-level overview of some of the options. The information below is a summary guide. You will want to work with a tax accountant, lawyer, plan provider, or employee benefits company to find the best fit for you. I’ll give you some resources later to point you in the right direction for more information.

These plans have a wide range of complexity and costs. I’ll give a summary rating of low, medium, or high for these factors. I’ll also note whether contributions are made by just employees, just you as the employer, or both.

The rules for these plans and the allowable contribution amounts are constantly changing. There are ways some participants are capped below the maximum contribution amount. There are also ways a participant might be able to contribute more than the standard maximum contribution. For example, many plans allow higher contribution amounts for participants age 50 or older. The maximum standard contribution amounts for 2019 used below are only an approximation. You will need to research the plans further to see what you and your participants would be able to contribute.

Documents about Individual retirement account IRA on a desk.

Payroll Deduction IRA

Plan administration complexity and cost: Low
Maximum contribution: $6,000
Who contributes: Employee Only

“IRA” is an acronym for Individual Retirement Account. Many of your employees may have IRAs that they set up personally. This plan allows your employees to have their IRA contributions automatically deducted from their paychecks. You will need to have a way for employees to elect the deduction, process the deduction in your payroll system, and then remit the funds to their IRA. You are providing a way to make retirement savings easier for your employees at very little cost to you.


Plan administration complexity and cost: Low
Maximum contribution: $13,000
Who contributes: Employee and employer
Your employees can elect to have IRA funds deducted from their paycheck and you as the employer must pay a match for a portion of that. Employees can contribute more to their IRA in this plan than they can in a Payroll Deduction IRA.

Simplified Employee Pensions (SEPs)

Plan administration complexity and cost: Low
Maximum contribution: $56,000
Who contributes: Employer Only
You set up a SEP IRA for yourself and each employee. You usually must contribute a uniform percentage of pay to everyone. The main benefit of this plan is that you can contribute a very high dollar amount compared to other plans. There is a form to set up the plan but no annual filing.

Profit Sharing Plan

Plan administration complexity and cost: Medium to High
Maximum contribution: $56,000
Who contributes: Employer Only
This is not an IRA or a 401K but allows tax benefits similar to them. There are a wide variety of ways this can be set up. Contributions are discretionary so you do not need to contribute each year. This plan may be a good option for companies with very volatile cash flows or income.

Paper with 401k plan on a table

401(k) Plans

Plan administration complexity and cost: High
Maximum contribution: $19,000 by employee and $56.000 for combined employee and employer
Who contributes: Employee and/or Employer
These plans are named after section 401(k) of the IRS tax code that allows retirement tax benefits. Many large employers offer 401(k) plans to their employees. There is a wide variety of how these plans can be designed. Amounts that highly compensated employees can defer might be capped based on how much all the other employees defer (i.e. nondiscrimination testing). You can also join an association retirement plan (ARP) that allow small businesses to band together to reduce administration costs.

SIMPLE 401(k)

Plan administration complexity and cost: Medium
Maximum contribution: $13,000 by employee and $56.000 for combined employee and employer
Who contributes: Employee and/or Employer
A company with 100 employees or less can choose what’s called a SIMPLE 401(k) that’s less complex than a standard 401(k) plan. It does not allow as much flexibility as a regular 401(k) for how much the employer contributes. Employees are immediately 100% vested for all contributions, including employer contributions. The employee contribution limits are lower than a standard 401(k). One benefit vs a standard 401(k) for small business owners is that contributions are not subject to the nondiscrimination rules.

Deferred Benefit Plans

Plan administration complexity and cost: High
Contribution Amount: Any amount needed to fund obligations to employees of the plan
Who contributes: Employer Only
All the plans above are considered “defined contribution” plans because the amount of the contribution is set (“defined”) by the employee and/or employer. The employee then receives whatever amount that grows to when they want to withdraw the funds. In a defined benefit plan, the employer promises retirement benefits based on a formula. This formula is often based on the employee’s length of service and how much they earned in compensation during their employment. The employer takes on the risk of paying whatever is needed to fund the promises they made to employees. It’s a long-term commitment. Some employers may choose this because they feel it will take better care of employees that are unable or unwilling to use a defined benefit plan. These plans have very high flexibility in design for owners’ needs.

Where to Go From Here

Train Tracks

In summary, you now:

  • Know your goals for the plan
  • Have identified key benefits you want to plan to provide
  • Understand a few aspects of some plan options

You’re on the right track but this is just the beginning of the journey. A couple of the best places to start for further internet research are provided by the government:

These are good sources for general educational material. You will want to set up a plan for the unique circumstances of your business and that supports your personal financial plan. The informational websites I listed above have tons of great content but it may be overwhelming. You have so many plan options to choose from. There are people who can guide you through all this. The advisors you will want to work with include:

  • Retirement Plan Providers or Brokers: This may be the same employee benefits broker or human resources consulting firm that you use for your medical benefits. Large financial services firms are another source for retirement plans. You may work with an investment advisor who says they can also manage the retirement plan of your company. Unless you have a very simple plan, it’s best to work with advisors or brokers who have extensive experience with retirement plans.
  • Personal Financial Planners and/or Tax Advisors: These professionals will be able to guide you on what’s best for your personal finances as the owner of the business. The planner helps you set your overall financial plan. The tax advisor can identify the best tax strategy for the plan based on your unique circumstances.

The steps in this article have given you clarity that will greatly help you as you continue to consider a retirement plan. The advisors I listed above can work with you to find the best small business retirement plan options for your business.

They can help you set up a plan but it all starts with the purpose, plans, and cash flow of your company. My ACE program is can help you with that. I can help you identify the goals for your plan and help you explore which benefits might be the highest priority for your business.