One of the biggest surprises for me as a blogger was the retirement plan options available to a small business owner. While a 401k maximum contribution is $17,500 (as of 2014) and an IRA is $5,500 (as of 2014), as a small business owner I can sock away more than $50,000 a year. It almost seems unfair.
Recently I’ve received email from readers wanted to know more about their options. While I have experience with a SEP IRA, I’m by no means a retirement plan expert. So I invited Brian Hogan to be a guest on the Dough Roller Money Podcast.
Brian Hogan is Fidelity’s Director of Small Business Retirement Products. Since he lives and breathes this stuff everyday, he is the perfect person to give us a high level overview of retirement options for those that have their own business.
Here are the high level takeaways I got from the interview:
- The three main options are a SEP IRA, Individual 401(k), and a SIMPLE IRA. There are also defined benefit plans, but we didn’t cover those.
- For businesses with no employees, either a SEP IRA or Individual 401(k) will likely be the best option. They both allow a business owner to contribution more toward retirement than a SIMPLE IRA.
- An Individual 401(k) requires more paperwork than a SEP IRA, but it may enable a business owner to save more for retirement.
- An Individual 401(k) may also be preferable to a SEP IRA for those looking to do a backdoor Roth contribution.
- A SIMPLE IRA can be ideal for those with employees.
Rob: Brian, welcome to the show.Brian Hogan: Thanks Rob.Rob: I appreciate you taking the time to be with us today. I’m sure you’re quite busy at Fidelity. I’ve had a lot of questions from folks about small business retirement plans so I wanted to cover that with you. I understand that’s what you do, so why don’t you describe for us who you are and what you do at Fidelity?Brian Hogan: Sure. My name is Brian Hogan and I am the Director of Small Business Retirement Products at Fidelity Investments. I am responsible for our SEP IRA, Simple IRA and our self-employed 401k as well as our investment-only plan. Really, my job as a project manager involves everything from marketing to operations to service models to making sure our plans are compliance with everything that comes down legislatively.
Rob: Okay. How long have you been at fidelity?
Brian Hogan: I’ve been with Fidelity for 16 years.
Rob: Wow. Okay, well that’s great. Where are you located?
Brian Hogan: In Smithfield, Rhode Island.
Rob: Okay. Good. I actually spent a summer at Brown University so I’ve had my share of time in Providence.
Brian Hogan: Okay.
Rob: You mentioned SEP IRAs, Simple IRAs and individual 401ks. Did you also mention something like an investment-only plan?
Brian Hogan: Yes.
Rob: I’ve never heard of that. What is that?
Brian Hogan: It’s really our answer to a small market 401k. Because we don’t have a 401k plan for small business owners, generally what we’ll do is tell a small business owner they should get a TPA (third part administrator) then they can use Fidelity as the investment platform.
Rob: Okay. We will come back to all of those, but what I thought we’d do today is start with the simplest scenario and add complications to it. As a starting point, Brian, let’s talk about the person who has their own business, no employees. Maybe they’re a professional. Maybe it’s a side gig, but they have this income from their business. What are their retirement plan options? What are the options that are available to them to save for retirement?
Brian Hogan: For a sole proprietor, that single person, it’s really the SEP IRA, the self-employed 401k and the Simple IRA. Each one of them has their own unique benefits. The Simple IRA looks more like a 401k plan but the contribution limits are lower than they would be for a SEP IRA or a self-employed 401k. You very rarely see a sole proprietor opening a Simple IRA. The strongest choices are the best options for a sole proprietor would be a self-employed 401k or a SEP IRA.
Brian Hogan: Both having higher contribution limits of $53,000 for each of them. The decision as to which one to go for, for a small business owner really comes down to how much administrative work they want to do. There is a little bit more administrative work with a self-employed 401k. Once the assets reach a certain threshold there’s $5,500 reporting. Whereas, with a SEP IRA it’s really just that— an IRA. There is no complicated testing or reporting that has to be done.
Rob: Okay. So for the SEP IRA and the self-employed 401k the amount someone can contribute is the same—I think you said $53,000. Is that for 2014?
Brian Hogan: That’s for 2015.
Rob: Oh, 2015. Okay. But you said there is a little more paperwork with a 401k. If that’s the case, why would anyone pick the 401k option?
Brian Hogan: The advantage for a 401k option would be for a client who is making $100,000. They can max out their SEP IRA at 25 percent compensation which would only be $25,000. But if they went with a 401k option, they could still put in that 25 percent but then in addition, you can do a payroll deduction or an employee contribution up to $17,500. So with lower incomes you may be able to put more into a self-employed 401k than a SEP IRA.
Rob: Alright. That’s a good point. So these contribution limits— You mentioned $53,000. Take the SEP IRA for example. The contribution limit in 2015 will be $53,000 or 25 percent of your profit, whichever is lower.
Brian Hogan: Right.
Rob: Okay. So, if you make $53,000 in side income, you can’t take it all and stick it into a SEP IRA or 401k?
Brian Hogan: Right. That’s correct.
Rob: So there are two requirements. You’ve got that cap of $53,000 but it can’t be more than 25 percent of your income. If someone were to choose the 401k option, perhaps for the reason you just described, a couple of questions come to mind. The first is, if they’re 50 or older, do they still get that catch-up contribution as well for these types of small business 401ks?
Brian Hogan: They do.
Rob: Okay. But they don’t get it with the SEP IRA, am I right about that?
Brian Hogan: Right. There’s no catch-up contributions with a SEP IRA.
Rob: Okay. So if you’re 50 or better, as I like to say [laughter]… If you’re 50 or older, that might be another reason to consider a 401k as opposed to the SEP IRA?
Brian Hogan: Yes.
Rob: We’re going to talk a little bit more about it in a minute— well, let’s just talk about it now. A lot of folks that have self-employed income also have a day job. Maybe they do some freelance work on the side but they’re a W2 employee. They have 401k at work. If we assume they are maxing out their 401k at work, does that effect their contribution limits for their SEP IRA or self-employed 401k for their side business?
Brian Hogan: It does. There’s one we call 402g limit which is how much a person can contribute. So, if they’re maxing out their 401k at work and they’re making more than $53,000 in 2015, this would be reduced by whatever they put into their 401k at work.
Rob: I see. Would the same be true with a SEP IRA?
Brian Hogan: Yes.
Rob: I have to tell you, Brian. I’ve heard this two different ways. I’ve heard that contributions to a 401k at work do reduce, in this case, the $53,000 limit. But I’ve also heard from a number of sources that they do not. And I confess, this has been an area of frustration for myself as well so let’s break it down. You mentioned that with the 401k option, you’ve got the $53,000 limit which is your max limit. But, if you don’t make enough income from your self-employed work you won’t be able to put it all in but you could do an employee contribution up to $17,500. What I’ve heard is, if you also have a day job and you contribute to the 401k at your work and max out, that would eliminate your ability to contribute the employee contribution piece of your 401k for your side business. Let me just stop there. That absolutely is correct, right?
Brian Hogan: That is correct, yes. If you maxed out your $17,500 employee contribution, you would not have the ability to make an employee contribution into your self-employed 401k.
Rob: And you can have five different jobs with five different 401ks and your limit is still $17,500 in the aggregate?
Brian Hogan: Correct.
Rob: Right. So whether it’s your self-employed income or maybe you have two or three job or whatever. What about the 25 percent of your profits? Can you still contribute 25 percent of your profits up to the $53,000 limit in a 401k or SEP IRA?
Brian Hogan: Yes, but it is an aggregate. Same as it is with the 401k.
Rob: I see. But don’t they— I feel like I’m arguing with you, Brian. And I know you’re the expert so please forgive me. It’s the lawyer in me. I can’t help myself. There’s certainly an employee limit which we’ve been talking about. There’s also an employer limit— that’s the $53,000.
Brian Hogan: Right.
Rob: But I’ve understood them to be two different things. There is an employee limit which follows you no matter how many jobs you have. But, for example, I’ve heard if you have two fulltime jobs that are totally independent of one and other and there are no common ownership in the companies and your employers just want to give you 25 percent of your income in a 401k up to $53,000, that they can do that. Is that not true?
Brian Hogan: They can. But again, it’s an aggregate limit. So if you’ve got two separate companies you can’t put more than $53,000 into your SEP for one year.
Rob: I see. Okay. So I guess the long and short of it is, if you are working a day job and you’re contributing to a 401k you absolutely have to factor that in when you figure out your contributions into either a SEP IRA or self-employed 401k?
Brian Hogan: Yes, that’s correct.
Rob: Should your day job and the 401k you have there, affect which option you choose for your self-employed income? That’s between a SEP IRA or a 401k?
Brian Hogan: It depends on a lot of things such as, are you maximizing your contributions at you day job? Is your employer matching anything at your day job? Then, after you answer both of those questions you have figure out what makes more sense… Do I want to go (for lack of a better term) easy and just do a SEP IRA? Or is the self-employed 401k more advantageous just because I haven’t reached my $17,500 in my day job.
Rob: Right. You mentioned the extra paperwork for the 401k. Fidelity offers a SEP IRA, right?
Brian Hogan: Yes.
Rob: And does Fidelity offer a self-employed 401k? Or they don’t?
Brian Hogan: We do, yes.
Rob: Are the fees— not the investing fees because obviously, there are fees for mutual funds or ETFs you might choose to invest in. But, are there account management fees for either the SEP IRA or the self-employed 401k?
Brian Hogan: No, there are no account setup fees and no annual maintenance fees for either account.
Rob: Oh, okay. So cost wouldn’t be a deciding factor. At least, if folks chose to use Fidelity?
Brian Hogan: Right. That’s correct.
Rob: Alright. Before we move to the next layer of complication, you mentioned the Simple IRA and said the contribution levels are lower. What are they for a Simple IRA?
Brian Hogan: For 2015 it’s $12,000.
Rob: Why would anyone pick that?
Brian Hogan: Well, from what we’ve seen, you’ll find a lot of blue collar small businesses— landscape companies, auto-body shops… It’s generally for— The Simple IRA makes more sense for smaller companies with employees that want their employees to be able to contribute.
Rob: Actually, that was a good Segway because that was my next layer of complication. Although, really quick, before we get there, are there Roth options? Can you open a Roth SEP IRA or a Roth self-employed 401k?
Brian Hogan: Roth self-employed 401k contributions are allowed. However, we don’t offer them here at Fidelity. The original Roth option with the SEP are the Simple IRA.
Rob: Okay. I’m curious as to why Fidelity doesn’t offer that. Have you just not seen a demand for it?
Brian Hogan: It’s a lot of work administratively to re-compete the Roth contributions and we really haven’t seen a demand for it.
Rob: Okay. Interesting. Alright, let’s move to the next level of complication you eluded to with the Simple IRA. Let’s think about a business where— maybe it’s not a large business, but they’ve got three, four, five or maybe even 10 employees. Let’s start again with just a list. What are their options? Are they the same, the SEP IRA, 401k and Simple IRA or are there other options that folks should consider?
Brian Hogan: It really is the same three options. The SEP IRA, Simple IRA and the 401k plan.
Rob: Okay. So walk us through. If you have employees does that change the analysis that someone should go through to decide what’s best for their company?
Brian Hogan: The first question for the owner of the company is, how much are they going to put away if they want to maximize their contributions? The second question would be, do you want your employees to be able to contribute to the plan? For example, for a SEP IRA, if you’ve got five employees and you decide you’re going to put away 25 percent of your own compensation for yourself as the owner, you also have to put away 25 percent of each employees compensation of their behalf.
Rob: Okay. And for which plans does that apply? Or does it apply to all of them?
Brian Hogan: That’s the SEP IRA.
Rob: The SEP IRA. Okay. With the SEP IRA they are all considered employee contributions, is that right? Or can employees also contribute to a SEP IRA?
Brian Hogan: No, they’re all employer contributions.
Rob: So if you set up a SEP IRA, whatever percentage of your income, you being the owner, up to 25 percent, you’ve got to give the same percentage to your employees?
Brian Hogan: That’s correct.
Rob: Before we go to the next ones, is there any limits of that in terms of how many hours the employee works or how long they’ve worked for you?
Brian Hogan: You can basically write it in. You can design your own plan as you see fit. With the government’s 5305 form, there are no limits.
Rob: Okay. I’ve heard that if an employee hasn’t been there for a year, for example, you can have a plan that does not have a retirement plan for them, or if they work fewer than 1,000 hours. Does that not apply? Or is that maybe a different plan?
Brian Hogan: That’s a Simple IRA.
Rob: Okay. Fair enough. I’m getting ahead of myself. Alright. So you’ve described the SEP IRA for us so should we go to the Simple IRA?
Brian Hogan: Sure. The Simple IRA, again, looks and feels like a 401k plan. The employees can make payroll deduction contributions, employee contributions and then the employer can choose to match those contributions up to 3 percent of compensation.
Rob: I see. Is a Simple IRA what you see to be the most popular option for folks with small businesses?
Brian Hogan: I wouldn’t say the most popular. But I would say it’s probably the best option for four to five employees, I think, just because of the publicity 401ks get. Most small business owners— that’s what they’ve heard of is the 401k. They’ve never heard of a Simple IRA so when they go out to look for a retirement plan they automatically think, 401k plan—
Rob: And what are the advantages— I’m sorry. Go ahead.
Brian Hogan: Unfortunately, a lot of small businesses end up in a 401k plan they can’t afford.
Rob: Explain that to me. What are the differences between a Simple IRA and a 401k and why would a small business be unable to afford a 401k?
Brian Hogan: For a Simple IRA, the majority— we charge a $350 plan fee here at Fidelity. But that’s it. That’s the only fee associated with it other than the fees on the investments. With a 401k plan, you’re going to pay a lot more administrative fees for testing, for loans or any other features that you add to a 401k plan which you may not necessarily need for such as small company.
Rob: Okay. The 401k plan— again, for small businesses with employees can end up being a lot more expensive?
Brian Hogan: Exactly. Even with a collection of doctors or lawyers who have a higher income and want to do certain things in their retirement plan, a 401k may make more sense because it may be worth the money to pay for those extra features. But for your average mom and pop shop with just four or five employees, the Simple IRA makes a lot more sense.
Rob: That makes sense. I take it though, with the Simple IRA, am I correct that that would also limit the amount of money that the owner could put away for retirement?
Brian Hogan: Yes, it does.
Rob: I think you said earlier the total limit is $12,000? Is that right?
Brian Hogan: That’s correct, yes.
Rob: Right, right. I guess it’s, just like with everything, there’s pros and cons. Obviously fees are less but your limits are less too. One plan we’ve not talked about is a defined benefit plan. Is that something that Fidelity offers to small businesses?
Brian Hogan: We don’t actively sell defined benefit plans any longer.
Rob: Okay, alright. Well maybe we’ll put that issue off. That’s one of the things that I’ve looked at extensively for myself but have been too scared to pull the trigger on it because there are a lot more requirements, you know…
Brian Hogan: [Laughter]
Rob: It’s not as simple as just deciding how much you want to put away each year. Okay, so this has been very helpful. We’ve got the SEP IRA, the self-employed 401k and the Simple IRA. To summarize, if you’re solo, by yourself with no employees, it sounds like it’s either going to be the SEP IRA or the self-employed 401k.
Brian Hogan: Correct.
Rob: Right. And there can be some reasons for the 401k particularly if you don’t– it may allow you to contribute more on the employee side and also if you’re 50 or older, but you’ve also got to be mindful of any retirement contributions you make at a job where you’re maybe a W2 employee?
Brian Hogan: Right.
Rob: Then when you start to have employees, that’s when the Simple IRA starts to look a little more attractive because it’s simple and it’s not as expensive as a 401k?
Brian Hogan: Right.
Rob: Is there a limit to the number of employees you can have and still use a Simple IRA?
Brian Hogan: A Simple IRA limit is 100 employees.
Rob: Okay. So once you get above 100, which I don’t think I’d call a small business anymore, but I guess it is, you’d be looking at a 401k for the most part?
Brian Hogan: Right.
Rob: Okay. Alright. That’s been very helpful because it’s framework that I’ve just never focused on. I’ve always had a SEP IRA and one of the things I’m thinking about is switching to a 401k because I want to do a back-door Roth and I can’t do it with all of this pre-tax money in IRA accounts. That may be another factor for some folks too. But it’s been very helpful to sort of frame this out for me and to know what the options are. I appreciate that. Is there anything we’re missing? Is there anything else we should have covered on these retirement plans that would help folks make that final decision of what’s best for them?
Brian Hogan: I think, again, the important parts are, how much does the business owner want to contribute on their own. Do they want their employees to be able to contribute (if they have any) and really, what is your goal? Is it to maximize your contributions or reduce your paperwork? What’s the administrative burden?
Rob: Right. On the 401k, who does the paperwork? If someone opens it up at Fidelity, does Fidelity help them with that paperwork or does the business owner go out and get a tax accountant to do that kind of work?
Brian Hogan: Here at Fidelity they’d have to go out and get a tax accountant to do that work for them.
Rob: Alright. Okay. So that would be an added cost for the 401k. That’s good to know. Well Brian, listen… I appreciate your time so much today and your information on these retirement plans.
Brian Hogan: No problem. Thank you for your time.