by Phillip Bollin, Certified Financial Planner TM
While there are other options available, I generally recommend one of four retirement plan types to entrepreneurs. All four of these plans are well suited to the needs of solo entrepreneurs, and some of them offer the flexibility to serve a small-business owner who brings on employees.
The four plan recommendations are Simple IRAs, SEP IRAs, Solo or regular 401(k)s or Contributory IRAs (Roth or Traditional).
For solo entrepreneurs, any of the four plans will work extremely well. If the business owner is just starting out and has limited compensation, then the contributory IRA option might be the best option.
If the business owner can afford to put more away than traditional or Roth IRAs permit, then the SEP IRA, Simple IRA or Solo 401(k) options will all work well. Simple IRAs will not allow as much deferral as either a SEP IRA or Solo 401(k), but they are very easy to set up. For the solo entrepreneur, the key determinant for me between a SEP IRA or Solo 401(k) would be whether the business owner would like the possibility of accessing the money in the form of a loan for business purposes. If so, then I would advise him or her to choose the Solo 401(k) plan.
Most Solo 401(k) plans do not have any more reporting requirements than the SEP IRA does, but not every Solo 401(k) provider allows loans, and some of the providers who allow loans limit their participants to proprietary fund choices in the 401(k).
For entrepreneurs with employees, the considerations change a bit. The lowest cost approach for the business owner would be a payroll-deductible contributory IRA, but that also allows the lowest amount of compensation deferral. Most entrepreneurs cannot afford to be extra generous to employees when starting out, so either a Simple IRA or 401(k) plan generally makes more sense than the SEP IRA option.
Plan costs and compensation deferral amounts are the trade-offs to consider when choosing between the Simple IRA and 401(k). The 401(k) allows a higher deferral amount, but also carries higher costs and possible compliance testing and a higher administrative burden than the Simple IRA.
Generally speaking, most small companies I work with opt to start with a Simple IRA because of the lower cost and lighter administrative burden, and then transfer those assets into a newly formed 401(k) plan after two or three years when the plan costs are more easily absorbed.
SEP IRAs generally work well for partnerships or companies with few employees, since the funding comes solely from the employer, although the employer does have some flexibility in choosing whether to make contributions or not in any given year.
See the detailed chart for more information: