Retirement Plan Options for S-Corps

Retirement planning for S Corporations is perhaps the most important tax savings strategy because it allows you to make tax free (or tax deferred) contributions that lower the tax you pay (either now or in the future). If your business is making more money than you spend, and you are just leaving the excess cash in the business or taking it out of the business and just saving/investing it on your own, you are paying more tax than you should!

In this article we’re going to discuss the three primary types of retirement plans for small businesses (and their owners) and talk about some of the trade offs between each type. Before we get into how the plans are different, let’s start with a few key things that are generally true for each plan:

Whatever plan you offer yourself (as an owner or employee of the business), you also have to offer to your employees. However, there are strategies for getting around this to some extent that are outside the scope of this article.
What you put into a plan is typically “tax deferred” which means you don’t pay taxes on money you put into a plan this year, but do pay tax if you take money back out.
Generally there are penalties for taking money out of a plan before you reach retirement age (age 59 and a half for most purposes).

Now that we’ve covered the basics, let’s dive into the options.

Three Retirement Plan Options for S-Corps

Simplified Employee Pension (SEP)
Solo 401k
Savings Incentive Match Plan for Employees (SIMPLE)

Each of the above are significantly better than saving/investing without a plan, but there are significant differences between them. Depending on certain factors, like the number of full-time employees you have and how much you wish to contribute annually, one option will be better than the rest.

Let’s start with a brief overview of each.

Simplified Employee Pension (SEP)

We’re here to be helpful, so we’ll start with what is normally the best option. The simplified employee pension (SEP) is generally the best option for S-corp owners because it allows the employer (your S-Corp) to contribute up to $61,000 per employee, per year to the plan (and small business owners are typically also employees of their S-Corps, so count yourself in!). This $61k limit is the highest of all the plans, so if you’re looking to save as much as possible, this is likely the answer. It’s also great because you can change the amount you contribute each year, so you’re not tied to contributing some specific number in the event you have a bad year and can’t afford to contribute.

However, there are some limitations (it is the IRS we’re dealing with after all).

Contributions are only made by the employer (not the employees) so this doesn’t give your employees an easy way to save on their own – they would have to set up their own IRA if they want to save above what the business contributes to the SEP on their behalf. Setting up an IRA is pretty easy though, so we don’t think this is a big deal.
That $61k limit is further limited to 25% of the employee’s compensation, so in order to hit the $61k max for yourself (or an employee) you have to be paying yourself $244,000 (or more specifically, paying yourself $183k and putting an additional $61k into the SEP). That said, you certainly don’t have to hit the limit, so you get to put 25% of your salary into the SEP, regardless of what that number is. Again, not a huge drawback in our opinion.
The one major drawback we do see though, is that you can’t borrow from the pension and neither can your employees. We’ll talk about this option to borrow more when we get into 401k plans below, but it suffices to say this is simply not an option, and you can’t even use the SEP funds as collateral for a loan from somewhere else, so once it’s contributed, it’s locked up unless you withdraw it

Savings Incentive Match Plan for Employees (SIMPLE)

A SIMPLE IRA plan allows employees (and their s-corp employee owners) to contribute to traditional IRAs. It can be a convenient option for small employers looking for their first retirement plan that don’t want to spend too much on additional employee compensation via the plan. There are no filing requirements with the SIMPLE IRA plan, and it offers an employer matching scheme that s-corp owners can utilize. An interesting aspect of the SIMPLE IRA plan is it is available to companies with less than 100 full-time employees, which means it works well for small S corporations, but isn’t available to larger companies.

Under a SIMPLE plan, the employer is required to contribute either:

A 3% match of any employee contributions (not limited by annual compensation limits)

A 2% non-elective contribution for each eligible employee

So if you’re reading this as the owner of an s corporation, and you have a lot of employees that you don’t really want to pay more than you’re already paying them, but still want to save yourself for retirement in a tax-efficient way, this can be a great option. If you choose the match, and your employees don’t actually contribute much (they normally don’t) then you’ve created a pre-tax way to save for retirement without paying your employees significantly more.

Solo 401k

The solo 401k is a great option for self-employed s-corp owners who want to save for retirement. It allows you to contribute up to 25% of your salary (just like a SEP) as the employer and as the employee, but the dollar limit is a lot lower at only $20,500 (as of 2022). While the absolute maximum contribution limit is a lot lower, one compensating tradeoff is the ability to take out a loan against the solo 401k before you retire, which you can’t do with a SEP.

If you’re considering the Solo 401k because you’re not going to contribute more than around $20k anyway, and want the flexibility of borrowing against it in the future should you need it, keep in mind that the solo 401k is unavailable to s-corp owners who have additional full-time employees (your spouse doesn’t count).

Give us a call if you’re ready to let us handle the books, so you can handle business!