Retirement Plan Options for Small Businesses

Why offer a retirement plan at all

Small businesses employ roughly half of all private sector workers in the country, yet most of them still don't offer a retirement plan. Employer sponsored plans have become a central piece of how people actually save for retirement, and they're also an increasingly important tool for attracting and keeping the employees you need to stay competitive.

Beyond helping your employees, a retirement plan can benefit you directly as the business owner. The advantages typically include tax deferred growth on earnings inside the plan, current tax savings on your own contributions, immediate tax deductions for employer contributions, relatively simple setup and maintenance, and a benefit your employees genuinely value at a comparatively low cost to you.

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Defined benefit versus defined contribution plans

Most private sector retirement plans fall into one of two broad categories. Defined benefit plans promise a specific retirement benefit to each participant, and can allow for relatively rapid asset accumulation. The required contribution is actuarially calculated each year based on factors like age, years of employment, the target benefit, and current plan assets, so contributions are generally required annually and can vary significantly year to year.

Defined contribution plans work differently: there's no promised benefit amount at retirement. Instead, the employer, the employee, or both contribute to each employee's individual account, sometimes at a set rate such as 5 percent of salary. A 401(k) is the most familiar type of defined contribution plan, alongside profit sharing plans, money purchase plans, and employee stock ownership plans.

Small businesses can choose either approach. Many financial institutions offer pre-approved "prototype" plans of both types. When a plan meets the tax code's requirements, it's considered qualified and unlocks four meaningful tax benefits: plan income isn't taxed while it's held in the trust, employers get a current deduction for their contributions, participants don't pay income tax on contributions made on their behalf until the funds are actually distributed, and beneficiaries of qualified plan distributions may receive special tax treatment under the right circumstances.

Every option here has real tax, business, and administrative implications, so it's worth discussing any plan you're considering with your accountant or financial advisor before committing to one.

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SIMPLE: Savings Incentive Match Plan for Employees

A SIMPLE IRA lets employees contribute a percentage of each paycheck, with the employer matching that contribution. Employees can set aside up to $16,500 in 2025 ($16,000 in 2024) through payroll deduction, with an additional catch-up contribution of $3,500 available for those 50 and older. Starting in 2025, employees who are 60 to 63 by year end get a higher catch-up limit, $5,250 for 2025. Employers can either match employee contributions dollar for dollar up to 3 percent of wages, or make a flat 2 percent contribution for all eligible employees regardless of what they personally contribute.

SIMPLE IRAs are genuinely simple to set up, a short form is usually all it takes, and administrative costs are low since much of the paperwork runs through the financial institution holding the accounts. Employees are 100 percent vested immediately, choose how their own money is invested, and keep their account even after they change jobs.

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SEP: Simplified Employee Pension Plan

A SEP plan lets you set up an individual retirement account, a SEP IRA, for yourself and your employees. Contributions have to be a uniform percentage of pay across employees, and employer contributions are capped at the lesser of 25 percent of an employee's salary or $70,000 for 2025 (up from $69,000 in 2024). Most employers, including those who are self employed, can start a SEP plan.

SEP plans have low startup and operating costs and can be established with a single, short form. You're also not locked into contributing every year, which gives you real flexibility when business conditions fluctuate.

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401(k) plans

401(k) plans are a widely used savings vehicle that let employees contribute part of their own income toward retirement. Employee contributions, capped at $23,500 for 2025 ($23,000 for 2024), reduce taxable pay before income tax, meaning the contribution goes in pretax. Employees 50 and older can make an additional catch-up contribution of $7,500 for 2025, and those age 60 to 63 by year end get a higher catch-up limit of $11,250 for 2025. Employers may choose to match a portion of employee contributions, which tends to boost participation.

401(k) plans are more complex to administer than SIMPLE IRAs, but they offer meaningfully higher contribution limits, which lets employees build up larger retirement savings over time.

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Profit sharing plans

Employers can also make profit sharing contributions independent of anything an employee personally contributes. These plans work particularly well for businesses with uncertain or fluctuating profits, since the employer has flexibility in deciding contribution amounts each year, and can also include features like service requirements, vesting schedules, and plan loans that aren't available under a SEP.

Contributions can range from 0 to 25 percent of eligible compensation, up to a maximum of $70,000 for 2025 (up from $69,000 for 2024) per employee, and the total contribution in a given year can't exceed 25 percent of the combined compensation of all participating employees. Contributions don't have to be the same percentage across employees, key employees might receive close to the full 25 percent while others receive as little as 3 percent, and a profit sharing plan can be layered together with 401(k) contributions and any employer match.

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Matching the plan to your actual goal

Business owners set up retirement plans for different reasons, and it's worth being honest with yourself about which one applies to you. Are you mainly trying to capture tax breaks and save more than you otherwise could? Provide a competitive benefit that helps you attract and keep employees? Or primarily save for your own retirement?

Most owners land somewhere in "all of the above," but small employers tend to fall into one of two broad groups: those who want a plan primarily to create a tax advantaged savings vehicle for themselves, allocating as much of the contribution as possible to the owners, and those who want a low cost, straightforward plan mainly for their employees. If there were a single plan that did everything equally well, there wouldn't be this many choices. Knowing your actual goal is what lets you weigh the tradeoffs and land on the right plan, rather than guessing.

If you decide to move forward with a plan, professional guidance is worth the cost. Pension rules are genuinely complex, and the tax aspects can get confusing quickly. Confer with your accountant before settling on the plan that fits you and your employees.

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