Retirement 101: Small Business Defined Contribution Plans

Now that you know about the bigger defined contribution plans, I want to focus on three specific accounts for small businesses with employees: the SEP IRA, SIMPLE IRA, and SIMPLE 401K.


SEP IRA stands for Simplified Employee Pension Individual Retirement Arrangement.  Business owners who wish to provide all retirement benefits to employees use this type of vehicle. In this plan, the owner makes contributions to each employee’s account. The employee, on the other hand, doesn’t contribute anything.  However, employees can invest in their own personal IRA accounts.

The amount the employer can contribute to the account can rise up to 25% of the employee’s compensation or $51,000 whichever is less.  The employee is always 100% vested in these funds. This structure represents the ultimate scenario of “free money” by an employer.

The employer can deduct these contributions as a business expense, and the employer can also choose when they want to contribute. In other words, there is no contribution requirement.  Many small employers like this added flexibility because of the varying cash flows of the business.

Generally, an employee is eligible for an account when he or she is at least 21, has worked for the employer the last three of five years, and received compensation of at least $600 for the tax year.


SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Arrangement. This plan not only allows for employer contributions, it also gives employees a chance to contribute. You can think of this plan as a starter 401k, without all of the administrative hassle.

The employer has two contribution options: 1) Match up to 3% of each employee’s compensation or $12,000, whichever is less, or 2) Contribute up to 2% of each eligible employee’s compensation up to $5,100 for 2013.  Like the SEP-IRA, the company can deduct these contributions as a business expenses.

Employees can contribute up to $12,000 per year, and $14,500 if they are age 50 or above.

Employees don’t have an age-restriction or minimum amount of years of  work to qualify for an account. However, the employee must earn a minimum amount specified by the employer during any two proceeding years and expect to earn at least, $5,000 in the current year. In addition, only businesses with less than 100 employees can use this plan.


Lastly, we have a SIMPLE 401k plan, which is a subset of the regular 401k. It mirrors the SIMPLE IRA plan, where the employer must match either 3% of each employee’s compensation or 2% of each eligible employee’s compensation.  In addition, the employees completely vest in all contributions to their account.

Employees can also contribute to this plan. Contributions cannot exceed $12,000 per year or $14,500 if age 50 or above. However, in this plan, as opposed to a SIMPLE IRA, employees can take loans from the account.  As I said yesterday, though, taking loans from a retirement plan should be a last resort.

In order to establish this plan, the business must have fewer than 100 employees, cannot have any other retirement plans, and must file an annual reporting form (Form 5500) to the IRS.

Easy setup, maintenance, and administration

The benefit of all of these accounts comes from their low costs to setup, ease in maintenance and administration, and flexibility with contributions. The larger plans have many testing and administrative requirements because of Department of Labor regulations. These smaller plans avoid all of that because of their limited scope and size.  Therefore, these plans offer a great benefit for small employers that already have to juggle several balls at one time.  For that convenience, however, small business owners have lower contribution limits.

Now that we know the fundamentals about the different accounts, we need to figure out the best way to make whichever vehicle you have work for you. Stay tuned.