Choosing Small Business Retirement Plan SEP-IRA SIMPLE IRA

[schmerna]

DH has started a new business in 2022 thanks to FU money.  I am researching options for a retirement plan.  I have been doing some research on both Fidelity and Vanguard options.  Any thoughts on either vendor?  The best fits seems to be a SEP-IRA or SIMPLE IRA.

The Details:
LLC, S Corp
Three employees in 2022
Perhaps 20 employees by year 5

Compensation in the first part of 2022 will be very low if any.  Hopefully, they will start taking salary in Q3 & Q4.

It seems like the SEP-IRA would not allow DH to have any tax-deferred plan, so our tax bill would increase compared to if he had a 401k.  Is this correct?

He has some money in an old tIRA.  Can these be rolled into a SEP or SIMPLE IRA to allow for a backdoor Roth?  I understand the backdoor Roth may be going away.  Other than the backdoor Roth is there an advantage to having the money in the SEP/SIMPLE IRA?  Similarly, any thoughts on rolling over an old 401k into either?

The SEP-IRA seems very favorable to the business side of taxes and the SIMPLE IRA seems more favorable to our personal (MFJ) taxes.  Is that correct?

What else do I need to think about?

[schmerna]

Also, I am considering a regular 401k.  It looks like the administrative fees will be higher with that option.

Has anyone used a 401k option for such a small number of employees?

[gardenstash]

I have a 401k for my business with five non-owner employees. I use Guideline.com. I think we pay around $70/month for their Core plan (https://www.guideline.com/pricing)

The issue is that I really can't put much into the 401k because I can't have more invested than my employees. They don't put a lot in so I'm only able to put in about $1,200-$2,000 a year.

I'm spending like $840/yr so me and business partner can invest like $2,400-$4,000 total. But it's a benefit to the two employees that use it who have been with us for a long time so I offer it.

[terran]

Since you have employees, I think it will mostly come down to whether and how much you want to contribute to their plans. Probably a good bit of whether any plan is worth it will come down to whether it helps with recruitment and retention and the tax savings for your own contributions would only be a side benefit.

If you decide to go with a 401(k), in addition to Guideline which was already mentioned, check out https://www.employeefiduciary.com/

I have a 401k for my business with five non-owner employees. I use Guideline.com. I think we pay around $70/month for their Core plan (https://www.guideline.com/pricing)

The issue is that I really can't put much into the 401k because I can't have more invested than my employees. They don't put a lot in so I'm only able to put in about $1,200-$2,000 a year.

I'm spending like $840/yr so me and business partner can invest like $2,400-$4,000 total. But it's a benefit to the two employees that use it who have been with us for a long time so I offer it.

It would mean you'd need to make contributions to your employee's 401(k)s (4% match with two ways of calculating that or 3% contribution regardless of what they put in), but I'm pretty sure a safe harbor plan would let you max out your salary deferral contribution ($20,500 in 2022).

[frugalnacho]

I have a 401k for my business with five non-owner employees. I use Guideline.com. I think we pay around $70/month for their Core plan (https://www.guideline.com/pricing)

The issue is that I really can't put much into the 401k because I can't have more invested than my employees. They don't put a lot in so I'm only able to put in about $1,200-$2,000 a year.

I'm spending like $840/yr so me and business partner can invest like $2,400-$4,000 total. But it's a benefit to the two employees that use it who have been with us for a long time so I offer it.

Why don't you change it to safe harbor rules?  Might cost a little bit more since you'll be "matching" 3% of your employees salary regardless of how much they contribute, but you'll be able to use the full $20.5k limit for this year. 

[SeattleCPA]

Also, I am considering a regular 401k.  It looks like the administrative fees will be higher with that option.

Has anyone used a 401k option for such a small number of employees?

So this real life observation...

It may be that the only people who need or want the higher limits offered by a 401(k) as compared to a Simple-IRA are the owners. I.e., most of your small business's employees probably won't hit the Simple-IRA limits. They'll be saving some amount that gives them the match amount. Or that's IRA-ish in size.

When that's the case, it's kinda uneconomical to pay for even an economical 401(k) like Guideline (which we use in our CPA firm BTW) and pay the higher matching if only reason is to owner gets higher limits.

I bet a Simple-IRA works fine. And then you can upgrade at some point if it matters.

One other thought: Some employees will ask if you have a 401(k)... and if you have a Simple-IRA you'll have to say, "Oh, no, we have something similar... a 408(p) or Simple-IRA plan... works same way though..."

[gardenstash]

I have a 401k for my business with five non-owner employees. I use Guideline.com. I think we pay around $70/month for their Core plan (https://www.guideline.com/pricing)

The issue is that I really can't put much into the 401k because I can't have more invested than my employees. They don't put a lot in so I'm only able to put in about $1,200-$2,000 a year.

I'm spending like $840/yr so me and business partner can invest like $2,400-$4,000 total. But it's a benefit to the two employees that use it who have been with us for a long time so I offer it.

Why don't you change it to safe harbor rules?  Might cost a little bit more since you'll be "matching" 3% of your employees salary regardless of how much they contribute, but you'll be able to use the full $20.5k limit for this year.

I've thought about that but we lost a lot of business in 2020/2021 so it's been a keep the lights on situation so matching 3% right now isn't feasible and the tax savings I'm not sure would be worthwhile.

[frugalnacho]

What's the minimum amount of time a business can be established before starting a simple IRA?  All the providers I've looked at have language that says you are required to have at least 2 years of at least $5k in income.  Here is vanguard's:

Employees are eligible if they received at least $5,000 from you in any 2 preceding years and are reasonably expected to earn at least $5,000 in the current year.

And the IRS says something similar:

Participate in a SIMPLE IRA Plan
An employee (including a self-employed individual) who:

earned at least $5,000 in compensation during any 2 years before the current calendar year and
expects to receive at least $5,000 during the current calendar year.

But they immediately follow it up with:

An employer can use less restrictive participation requirements, but not more restrictive ones. For example, an employer can eliminate or reduce the prior or current year compensation amounts.

Which makes it seem like there is no actual minimum requirement.  But then I don't understand what the purpose of even stating a minimum requirement of "at least" $x in y number of years if the employer has discretion to waive that requirement.  The way it's worded seems really awkward and stupid.

[SeattleCPA]

What's the minimum amount of time a business can be established before starting a simple IRA?  All the providers I've looked at have language that says you are required to have at least 2 years of at least $5k in income.  Here is vanguard's:

Employees are eligible if they received at least $5,000 from you in any 2 preceding years and are reasonably expected to earn at least $5,000 in the current year.

And the IRS says something similar:

Participate in a SIMPLE IRA Plan
An employee (including a self-employed individual) who:

earned at least $5,000 in compensation during any 2 years before the current calendar year and
expects to receive at least $5,000 during the current calendar year.

But they immediately follow it up with:

An employer can use less restrictive participation requirements, but not more restrictive ones. For example, an employer can eliminate or reduce the prior or current year compensation amounts.

Which makes it seem like there is no actual minimum requirement.  But then I don't understand what the purpose of even stating a minimum requirement of "at least" $x in y number of years if the employer has discretion to waive that requirement.  The way it's worded seems really awkward and stupid.

I think that's right that you have some wiggle room about amounts you contribute. But you can and do need to cover employees immediately if others getting paid.

Not an issue in this example, but you can't wait until the end of the year with a Simple-IRA. Needs to be started by, hmmm, October 1 I think.

BTW you can do something like an SEP right up until the tax return is filed or the extension due date if extended, but if you've got employees, SEPs are problematic. First, you eventually need to treat everybody the same. Second, you can't just terminate the plan once you're covering non-owner employees.

Another random tip/idea: Sometimes you can get the Simple-IRA economics to work by planning ahead and budgeting for this. E.g., the match will cost 3% of employee wages. So maybe in this economy rather than (say) a 6% raise, you give a 3% raise and add a 3% Simple-IRA match.

[terran]

I haven't looked closely at SIMPLE IRAs, but at least with 401(k)s there's no minimum requirements, they set maximum requirements because it's usually in the business owners interest to be more restrictive as that minimizes the cost of administering and paying employee contributions to the plan. Otherwise a business owner could just set a requirement that meant now employee could ever participate in the plan.

[SeattleCPA]

I haven't looked closely at SIMPLE IRAs, but at least with 401(k)s there's no minimum requirements, they set maximum requirements because it's usually in the business owners interest to be more restrictive as that minimizes the cost of administering and paying employee contributions to the plan. Otherwise a business owner could just set a requirement that meant now employee could ever participate in the plan.

+1

Exactly. Conceptually, the laws limit the benefits that high income taxpayers, especially business owners, enjoy.

And then those laws try to protect the rank and file workers.

Despite anecdotal info like the Roth-IRA that Peter Theil orchestrated, tax-deferred accounts aren't designed to let a business owner get fabulously wealthy. They're designed to deal with reality of our economic system that people are supposed to save some of their earnings for their retirement.