Top 12 Small Business Owner Retirement Plan Options

For small business owners, introducing a retirement plan isn’t merely an additional benefit; it can deliver substantial tax savings, boost employee retention, and lay the groundwork for long-term financial stability—for you and your team.

Yet with options ranging from traditional 401(k)s to SIMPLE IRAs and cash balance plans, each structure comes with its own set of fees, administrative requirements, contribution thresholds, and eligibility rules. Understanding these variables is essential to tailor a solution that fits your business goals and budget.

Two additional points to consider: small employers may qualify for a tax credit that offsets startup expenses (IRS Retirement Plans Startup Costs Tax Credit), and ERISA fiduciary duties impose specific obligations to act in participants’ best interests (DOL EBSA guidance on fiduciary responsibilities). Below are 12 top retirement plan options to evaluate for your small business, each with key features, pros and cons, and setup considerations.

1. Traditional 401(k) Plan

A Traditional 401(k) is one of the most popular retirement vehicles for small to mid-sized businesses. It allows employees to defer a portion of their salary on a pre-tax basis into individual accounts, while employers can choose to match or make additional contributions. This flexibility, combined with high contribution limits, makes it a compelling option for businesses with several employees.

What Is a Traditional 401(k)?

A Traditional 401(k) is an employer-sponsored, defined contribution plan. Employees elect to defer part of their pay before income taxes are assessed, and employers may match a portion of those deferrals or make profit-sharing contributions. Funds grow tax-deferred until withdrawal.

Who It’s For: Companies of any size, but especially those with at least a handful of employees who want to offer a competitive benefit without the complexities of a pension.

Eligibility and Participation Requirements

To establish a Traditional 401(k), you must:

Adopt a written plan document that outlines eligibility, vesting, and contribution formulas.
Include all “eligible employees” under nondiscrimination rules—typically those age 21 or older with at least one year of service.
Define entry dates (often quarterly or annual) so employees know when they can begin deferrals and vesting.

Contribution Limits for 2024/2025

Employee salary deferrals: up to $23,000 in 2024 and $23,500 in 2025.
Catch-up deferrals (age 50+): an additional $7,500 each year.
Combined employee + employer contributions: up to $69,000 in 2024 and $70,000 in 2025.
With catch-up: $76,500 (2024) and $77,500 (2025).

Tax Advantages and Withdrawal Rules

Pre-tax contributions reduce current taxable income, and earnings accumulate tax-deferred.
Withdrawals after age 59½ are taxed as ordinary income; distributions before that generally incur a 10% penalty (with hardship and other exceptions).
Required Minimum Distributions (RMDs) must begin by age 73.

Pros and Cons

Pros:

Generous contribution limits help owners and key employees accelerate savings.
Employer matching or profit-sharing can incentivize and retain staff.
Tax-deferred growth maximizes compounding potential.

Cons:

Annual nondiscrimination testing (ADP/ACP) and Form 5500 filings are required.
Administrative complexity and recordkeeper fees can be higher than for simpler plans.
Corrections under the IRS’s Employee Plans Compliance Resolution System (EPCRS) may be needed if testing fails.

Setup & Administration

Adopt or amend a plan document that meets IRS/Department of Labor requirements.
Select a recordkeeper or custodian to handle investments, payroll deferrals, and reporting.
Draft a Summary Plan Description (SPD) and distribute it to participants.
Configure payroll to process employee deferrals and employer contributions.
Run annual nondiscrimination tests, file Form 5500, and correct any failures via EPCRS.

Many sponsors choose to outsource these tasks. For example, working with a third-party administrator like Summit Consulting Group, LLC can streamline compliance, reduce paperwork and potentially cut costs—learn more about their 401(k) plans.

Real-World Example

Imagine a 20-employee firm where the owner’s salary is $120,000 and the average employee salary is $50,000. The company offers a 4% match:

Owner match: 4% × $120,000 = $4,800.
Employee match cost: 20 × (4% × $50,000) = 20 × $2,000 = $40,000.
Total annual employer cost: $44,800.

If the owner also defers the maximum $23,500, their individual retirement contributions and match are fully tax-deductible, while employees benefit from both tax savings and the incentive to save. This structure balances generosity with predictable costs and clear compliance steps.

2. Roth 401(k) Plan

A Roth 401(k) is a variation on the traditional 401(k) that lets employees make after-tax contributions and enjoy tax-free growth and distributions in retirement. It’s a powerful tool for business owners and employees who anticipate higher tax rates down the road or want to diversify their tax exposure.

Overview of the Roth Feature

With the Roth option, contributions are made with dollars that have already been taxed. Once the funds are in the plan, earnings accumulate tax-free, and qualified withdrawals after age 59½ are completely exempt from federal income tax. This feature effectively combines the high contribution limits of a 401(k) with the tax benefits of a Roth IRA, without the income ceilings that apply to IRAs.

Eligibility and Plan Design

Adding a Roth bucket requires an amendment to your existing 401(k) plan document. Eligibility rules—in terms of age, service requirements and entry dates—mirror those of the traditional 401(k). Every employee who meets your plan’s written criteria can opt into the Roth feature, provided your plan administrator has enabled it. You don’t need to carve out different eligibility tiers or set up a separate plan.

Contribution Limits and Combined Deferrals

Deferral limits for Roth contributions are the same as for pre-tax 401(k) deferrals:

$23,500 in employee contributions for 2025.
An additional $7,500 catch-up for participants age 50 and over.

Employers may still make matching or profit-sharing contributions, but those have to go into the traditional pre-tax side of the plan. In other words, there is no separate “employer Roth” contribution.

Tax Treatment and Withdrawal Rules

Because Roth contributions are taxed up front:

There’s no immediate income tax deduction.
Earnings and qualified withdrawals after age 59½ (and after five years of participation) are entirely tax-free.

Unlike a Roth IRA, there are no income limits for making Roth 401(k) contributions. However, Required Minimum Distributions (RMDs) still apply at age 73. If you want to sidestep RMDs, funds can be rolled into a Roth IRA upon separation from service.

Pros and Cons

Pros:

Creates a pool of tax-free income in retirement, which can lower your future tax bracket.
No income caps—high earners can take advantage of Roth benefits.
Provides a hedge against rising tax rates.

Cons:

Contributions don’t reduce current taxable income.
Employees must decide how to allocate deferrals between pre-tax and Roth buckets, which may confuse some participants.
Plan reporting is slightly more complex, as Roth deferrals are tracked separately on Form 5500.

Setup & Administration

To implement a Roth 401(k):

Amend your plan document to include the Roth feature and notify participants of the change.
Ensure payroll systems can distinguish between pre-tax and Roth deferrals.
Record and report Roth contributions separately on annual filings like Form 5500.

Communicate clearly with employees about the pros and cons of Roth versus traditional contributions, and consider hosting a brief Q&A or distributing a comparison chart.

Example Scenario

Maria owns a graphic design studio and expects her tax rate to climb in retirement as she scales her business. By directing 50% of her own deferrals into the Roth portion of her 401(k), she locks in tax-free growth on that income. Meanwhile, her employees continue to make traditional pre-tax deferrals, allowing each person to choose the strategy that best fits their projected tax situation.

3. Solo 401(k) Plan

For businesses with just an owner (and perhaps a spouse), a Solo 401(k) can be the most efficient way to sock away retirement savings. Sometimes called a “one-participant” 401(k), this plan combines the generous deferral limits of a traditional 401(k) with the flexibility to vary contributions from year to year—ideal for entrepreneurs whose income can fluctuate.

What Is a Solo 401(k)?

A Solo 401(k) is a qualified, defined contribution plan designed exclusively for business owners with no common-law employees (aside from a spouse who elects to participate). Like a standard 401(k), it lets you make salary-deferral contributions and employer profit-sharing contributions, but you wear both hats: employee and employer.

Eligibility Criteria

Only the business owner—and their spouse, if the spouse works in the business—may participate. If you hire anyone else on a W-2 (beyond your spouse), the Solo 401(k) is no longer an option. That simplicity can reduce paperwork, but it limits participation to just you (and your spouse).

Contribution Limits for 2025

You get two opportunities to save:

Employee (salary-deferral) portion: up to $23,500, plus a $7,500 catch-up contribution if you’re age 50 or older.
Extra catch-up for ages 60–63: up to $11,250, thanks to provisions in the SECURE Act 2.0.
Employer (profit-sharing) portion: up to 25% of compensation.

Together, employee and employer contributions can total as much as $70,000 in 2025 (or $77,500 with catch-up contributions).

Tax Advantages and Withdrawals

Contributions you make as the “employee” are generally pre-tax, lowering your current taxable income. Earnings grow tax-deferred until you take distributions. Withdrawals after age 59½ are taxed as ordinary income; early withdrawals may incur a 10% penalty (with certain exceptions, such as disability). Required Minimum Distributions must begin by the year you turn 73.

Pros and Cons

Pros:

Very high combined contribution limits help maximize annual savings.
Spousal participation can double household retirement contributions.
No nondiscrimination testing reduces complexity.

Cons:

Once plan assets exceed $250,000, you must file Form 5500-EZ annually.
Hiring nonowner employees disqualifies you from using a Solo 401(k).
Plan administration—though simpler than a regular 401(k)—still requires adherence to IRS rules and deadlines.

Setup & Administration

Choose a provider or custodian that offers Solo 401(k) plans.
Adopt a one-participant plan document and obtain an Employer Identification Number (EIN), if you don’t already have one.
Open a separate trust or custodial account in the plan’s name.
Decide your employee and employer contribution amounts each year, then process deferrals through payroll.
Once plan assets cross $250,000, file IRS Form 5500-EZ by the deadline (generally July 31 following the plan year).

Best For

Solo 401(k)s are most suitable for sole proprietors, single-member LLCs, and partnerships without outside W-2 employees. If you’re looking to contribute the maximum allowed—especially in profitable years—this plan often outpaces IRAs and SEP IRAs in total savings potential.

4. Simplified Employee Pension (SEP IRA)

A SEP IRA is an employer‐funded retirement plan that’s structured like an individual retirement account but sponsored by the business. It’s ideal for small business owners who want both high contribution limits and minimal annual paperwork. Because it’s technically an IRA, the setup is straightforward, and you won’t have the same filing requirements as a traditional 401(k).

Overview of SEP IRA

SEP stands for Simplified Employee Pension. Instead of a trust, the plan is established using IRS Model Form 5305-SEP, which you fill out and keep on file. Employees each have their own SEP IRA account, but contributions are made solely by the employer—there’s no option for employee salary deferrals.

Eligibility and Coverage

If you adopt a SEP IRA, you generally must include all employees who:

Are age 21 or older,
Have performed services for you in at least three of the last five years, and
Earn at least $750 in the current tax year (indexed annually).

You may waive the service requirement for employees with longer tenure, but you can’t exclude highly compensated employees if they meet these criteria.

Contribution Limits

For tax year 2025, employer contributions to each eligible participant’s SEP IRA may total up to the lesser of:

25% of the employee’s compensation, or
$70,000.

There are no catch-up contributions for employees age 50 or older, unlike some other plans.

Tax Advantages and Withdrawals

Employers deduct SEP contributions as a business expense, lowering taxable income for the year. Funds inside a SEP IRA grow tax-deferred until distribution. When participants withdraw money—typically after age 59½—they pay ordinary income tax on both contributions and earnings. Early distributions may incur a 10% penalty plus income tax.

Pros and Cons

Pros:

Very simple to establish—just complete Form 5305-SEP.
No annual IRS filings or nondiscrimination testing.
Contributions are flexible: you decide each year whether and how much to contribute.

Cons:

If you contribute for yourself, you must contribute the same percentage for every eligible employee.
Costs can escalate if headcount grows, since the contribution percentage applies across the workforce.
No employee salary‐deferral feature, limiting opportunities for workers who want to save more.

Setup & Administration

Complete and sign IRS Model Form 5305-SEP; distribute a copy to each participant.
Establish a SEP IRA account for each eligible employee with your chosen custodian.
Make contributions by your business’s federal tax‐filing deadline (including extensions).
Maintain contribution records—no Form 5500 filing is required.

This light administrative load is why many professionals and small‐shop owners favor the SEP IRA.

Example Use Case

Consider a boutique woodworking studio with three employees. In a profitable year, the owner decides to contribute 20% of each person’s compensation to their SEP IRAs. If revenues dip the following year, the owner can scale back contributions to match cash flow, all without filing additional forms or running compliance tests. This flexibility helps the business manage its budget while still offering a generous retirement benefit.

5. Savings Incentive Match Plan for Employees (SIMPLE IRA)

A Savings Incentive Match Plan for Employees (SIMPLE IRA) is designed for businesses with 100 or fewer employees who want to offer a straightforward, low-cost retirement benefit. Unlike a 401(k), a SIMPLE IRA lets employees contribute a portion of their pay through salary deferrals and obligates the employer to make a matching or nonelective contribution.

With minimal paperwork and no annual Form 5500 filing requirement, SIMPLE IRAs can strike the right balance for growing companies that aren’t ready to absorb the complexity or cost of a traditional 401(k). However, the trade-off is lower savings limits and mandatory employer contributions. Below, we break down how SIMPLE IRAs work, who’s eligible, and when they make sense.

What Is a SIMPLE IRA?

A SIMPLE IRA is an employer-sponsored retirement plan that uses individual retirement accounts (IRAs) for each participant. Employees elect to defer up to a set dollar limit from their paychecks, and employers must contribute either a matching amount or a nonelective contribution. Funds grow tax-deferred until distribution.

Eligibility and Employee Coverage

To offer a SIMPLE IRA, your business must have:

100 or fewer employees who earned at least $5,000 in the prior calendar year.
A plan document set up using IRS Form 5304-SIMPLE or 5305-SIMPLE.

All employees who earned $5,000 or more in any two preceding years and expect to earn $5,000 in the current year must be allowed to participate.

Contribution Limits for 2025

Employee salary-deferral: up to $16,500.
Catch-up contributions (age 50+): $3,500.
Special catch-up (ages 60–63): up to $5,250 under SECURE Act 2.0.

Deferrals must be deposited into participant accounts promptly, generally within 30 days of payroll.

Employer Contribution Requirements

You have two choices each year:

Match employee deferrals dollar-for-dollar up to 3% of compensation, or
Make a nonelective contribution of 2% of compensation for every eligible employee, regardless of whether they defer.

Your election must be consistent for the entire calendar year.

Tax Advantages and Withdrawals

Employer and employee contributions are tax-deductible as business expenses.
Earnings grow tax-deferred.
Distributions after age 59½ are taxed as ordinary income.
Early withdrawals incur a 10% penalty, but if taken within the first two years of plan participation, the penalty jumps to 25%.

Pros and Cons

Pros:

Simple to establish and operate—no annual IRS filings.
Employee-owned accounts mean portability if someone leaves.
Mandatory employer contributions boost participant savings.

Cons:

Lower employee deferral limits than 401(k) plans.
You must contribute every year, even when cash flow is tight.
Matching versus nonelective choice can be costly with a large staff.

Setup & Administration

Choose and complete IRS Form 5304-SIMPLE or 5305-SIMPLE by October 1 (or within 60 days of starting your business).
Notify all eligible employees of plan details and their right to defer.
Help participants open SIMPLE IRA accounts with your chosen custodian.
Process deferrals through payroll and remit employer contributions by your tax-filing deadline (including extensions).
Maintain contribution and participant records—no Form 5500 filing is required.

When to Consider

A SIMPLE IRA is a solid fit if you have up to 100 employees, want an easy-to-run plan, and are comfortable making mandatory contributions. It’s a bridge between a basic payroll deduction IRA and the more robust—but complex—401(k), offering modest savings potential without the compliance burden of larger plans.

6. Defined Benefit Plan

Defined benefit plans—often referred to as pension plans—guarantee a specific retirement benefit based on a formula, rather than leaving your employees’ outcomes to market performance. For business owners, they offer some of the highest contribution limits available, making them an effective tool to accelerate retirement savings, especially for those nearing retirement.

However, this predictability comes with complexity: actuarial valuations, strict funding requirements, and ongoing administrative duties. Employers carry the investment and longevity risk, so it’s crucial to understand how these plans work and whether your business can sustain the obligations.

Definition and How It Works

A defined benefit plan specifies a retirement benefit in advance, commonly using a formula such as:

Benefit = Years of Service × Final Average Salary × Accrual Rate

Each year, an actuary calculates the amount the employer must contribute to fund those promised benefits. At retirement, participants receive a predetermined annuity or lump sum, ensuring a steady income stream regardless of investment returns.

Eligibility and Coverage

Under ERISA rules, you set eligibility criteria—often:

Minimum age (e.g., 21 years old)
Minimum service requirement (e.g., one year of service)

All employees meeting those criteria must be covered. You cannot favor highly compensated employees; the plan must apply uniformly unless specific, nondiscriminatory exceptions are invoked.

Contribution Requirements

Contributions are actuarially determined rather than fixed percentages. An actuary considers:

Projected benefit obligations based on the plan formula.
Expected investment return assumptions.
Participant demographics (e.g., ages, life expectancy).

Failing to contribute the full actuarial amount can trigger IRS penalties and increased required contributions in future years.

Tax Advantages and Distributions

Employer contributions are tax-deductible as a business expense.
Plan assets grow tax-deferred until distribution.
Participant benefits are taxed as ordinary income when paid out.
There are no statutory contribution caps—benefits hinge entirely on the plan formula and actuarial funding.

Pros and Cons

Pros:

Significantly higher retirement savings potential than defined contribution plans.
Predictable, guaranteed income stream for participants.
Especially attractive for owners over age 50 who have limited time to catch up on savings.

Cons:

High setup and annual actuarial, legal, and administrative fees.
Employer bears all investment risk and must meet strict funding obligations.
Complexity of annual valuations and Form 5500 filings.

Setup & Administration

Retain an actuary to design the benefit formula and determine funding obligations.
Draft and adopt an ERISA-compliant plan document.
Establish a qualified trust and appoint a trustee or oversight committee.
Make annual contributions by the corporate tax-filing deadline (including extensions).
Perform annual actuarial valuations, file IRS Form 5500, and conduct compliance testing.

Given the specialized expertise required, many sponsors engage a third-party administrator such as Summit Consulting Group, LLC to handle document preparation, funding calculations, and ongoing fiduciary compliance.

Ideal Scenarios

Defined benefit plans make sense when:

The business owner is within 10–15 years of retirement and needs to rapidly boost savings.
The company has stable, reliable cash flow to meet annual funding requirements.
There are few employees, or you’re prepared to fund benefits for a broader workforce.

7. Cash Balance Plan

A cash balance plan is a hybrid retirement vehicle that blends features of a defined benefit pension with the feel of an individual account. Instead of promising a fixed monthly benefit at retirement, it credits each participant’s “account” annually with a pay credit (a percentage of salary) plus an interest credit. This structure delivers predictable, level funding for employers and a clearer savings picture for employees.

While cash balance plans can supercharge retirement savings—especially for older business owners—they carry more complexity than a SEP IRA or solo 401(k). Actuarial input is essential to set the pay-and-interest credit rates and to handle annual valuations. Still, for a small team or an owner-only business looking to accelerate contributions, a cash balance plan can be a powerful tool.

What Is a Cash Balance Plan?

A cash balance plan is a type of defined benefit plan that represents benefits as hypothetical account balances instead of traditional pension annuities. Each participant’s “account” grows by:

A pay credit (for example, 5% of compensation)
An interest credit (either a fixed rate or tied to an index)

Participants see their growing balances year over year, much like a 401(k), but the employer bears investment and longevity risk.

Eligibility and Coverage

Coverage rules mirror those of standard defined benefit plans:

You set minimum age (often 21) and service requirements (commonly one year).
All employees meeting those criteria must participate.
Highly compensated or “key” employees cannot be excluded without nondiscriminatory justification.

If you hire additional staff, they join automatically—so be mindful of funding obligations.

Contribution and Growth Credits

Contributions aren’t discretionary: they’re determined actuarially based on the plan’s design and funding target. Each year, an actuary calculates the amount needed to fund:

Pay credits for all participants
Interest credits, using your chosen crediting rate (e.g., 4% per year)

Because the formula is built into the plan document, employers can predict funding needs well in advance.

Tax Advantages and Distribution Options

Employer contributions are tax-deductible and reduce current taxable income.
Plan assets grow tax-deferred until distribution.
At retirement or termination, participants typically choose between a lump-sum payment (the hypothetical account balance) or an annuity.

These tax benefits parallel those of traditional pensions but with greater transparency for participants.

Pros and Cons

Pros:

Enables high annual contributions—especially for owners in their 50s and 60s.
Level, predictable funding simplifies budgeting.
Participants appreciate a clearer “account” balance rather than an opaque lifetime benefit.

Cons:

Plan design and annual valuations require an actuary.
Higher setup and ongoing administrative fees compared to DC plans.
Interest credits tied to market indices can introduce volatility in funding requirements.

Setup & Administration

Engage an actuary to design the plan and calculate annual funding obligations.
Draft and adopt an ERISA-compliant plan document specifying pay and interest credit formulas.
Establish a qualified trust and appoint a trustee or oversight committee.
Make annual contributions by your tax-filing deadline (including extensions).
File Form 5500 and perform any required compliance testing.

Partnering with a third-party administrator can streamline these steps and help manage fiduciary responsibilities.

Best For

Cash balance plans suit owner-only or small-staff businesses that want to turbocharge retirement savings. If you’re within 10–15 years of retirement and can support consistent funding, this plan can deliver some of the largest allowable annual contributions while giving employees a straightforward account-style statement.

8. Profit Sharing Plan

A Profit Sharing Plan is a defined contribution arrangement in which an employer makes discretionary contributions to employees’ retirement accounts based on company profits. There are no employee salary-deferral elections; instead, you decide annually if and how much to contribute. This structure offers significant flexibility for businesses with fluctuating earnings.

Eligibility and Vesting

You establish eligibility parameters—commonly employees age 21 or older with at least one year of service. You also set a vesting schedule, often up to six years, either on a graded basis (e.g., 20% vested per year over five years) or via a cliff schedule (100% vested after a set period). Clear communication of these rules ensures employees understand when they fully own their benefits.

Contribution Limits

For 2025, your annual contribution for each participant cannot exceed the lesser of:

25% of compensation, or
$70,000.

Because contributions are discretionary, you can tailor funding to match your cash flow—boosting allocations in strong years and reducing or skipping them when needed.

Tax Treatment and Withdrawals

Employer contributions are tax-deductible, lowering your business’s taxable income. Once deposited, plan assets grow tax-deferred. Distributions taken after age 59½ are taxed as ordinary income; early withdrawals may incur a 10% penalty unless an exception applies.

Pros and Cons

Pros:

Flexible funding lets you align contributions with profitability.
Automatic participation once eligibility rules are met—no employee elections required.
Can be combined with other plans (like a 401(k)) for enhanced benefits.

Cons:

Year-to-year variability can make retirement planning harder for employees.
Plans covering more than 100 participants trigger annual Form 5500 filings and possible nondiscrimination testing.
Designing allocation formulas and managing administrative tasks can increase complexity.

Setup & Administration

Adopt a written plan document—select a prototype from your recordkeeper or craft an individually designed document.
Define eligibility criteria, vesting schedule, and your contribution allocation formula.
Coordinate with a recordkeeper or custodian to open participant accounts and process contributions.
For plans with over 100 participants, file Form 5500 each year and complete any required compliance testing.
Notify employees annually about contribution decisions, allocation methods, and vesting status via your Summary Plan Description and plan notices.

When to Use

Profit Sharing Plans are well suited to seasonal or cyclical businesses that need the flexibility to vary contributions based on annual performance. They’re also a smart choice when you want control over funding levels without requiring employees to make deferral decisions.

9. Employee Stock Ownership Plan (ESOP)

An Employee Stock Ownership Plan (ESOP) is a qualified defined contribution plan that invests primarily in the sponsoring employer’s stock. By placing shares in a trust and allocating them to employee accounts, an ESOP aligns the interests of staff and owners—while providing a built-in succession strategy for long-time business founders.

What Is an ESOP?

An ESOP functions as a trust that holds company shares on behalf of participants. Each year, the employer makes tax-deductible contributions—either stock or cash—to the ESOP trust. The trust then uses those contributions to purchase shares, which are allocated to eligible employees’ accounts. When employees retire or leave, the company repurchases their shares at fair market value, converting ownership into cash benefits.

Eligibility and Coverage

Under ERISA rules, you must include all employees who meet your plan’s age and service requirements—typically age 21 and at least one year of service. ESOP allocation formulas (often based on compensation) must be applied uniformly and nondiscriminatorily, ensuring that each participant receives a fair share of company stock.

Contribution and Valuation Rules

Contributions into an ESOP trust occur annually, and the trust either acquires newly issued shares or buys existing stock. Each plan year, an independent appraiser performs a valuation to establish the share price for both purchases and repurchase obligations. This fair market value serves as the basis for allocating shares to accounts and later repurchasing them from departing participants.

Tax Advantages and Owner Incentives

ESOP contributions are fully tax-deductible as a business expense, lowering corporate taxable income. In C corporations, selling shareholders can defer capital gains under IRC Section 1042 by reinvesting their proceeds in qualified replacement securities. Dividend payments on ESOP-held stock may also be deductible if passed through to participants or used to repay ESOP debt.

Pros and Cons

Pros:

Creates a clear succession and liquidity path for owners.
Builds an ownership culture that can enhance motivation and retention.
Offers substantial tax benefits, including deductible contributions and potential Section 1042 deferral.

Cons:

Upfront legal, valuation and trustee fees are significant.
Ongoing administrative duties—annual valuations, compliance testing and repurchase obligations—are complex.
Repurchase liabilities can strain cash flow when employees retire or depart.

Setup & Administration

To launch an ESOP:

Engage legal and tax advisors to draft the ESOP trust and plan documents.
Appoint an independent trustee to oversee the plan and protect participants’ interests.
Commission an annual independent valuation to set the share price.
File Form 5500 and perform required ERISA compliance testing each year.
Manage share repurchase obligations, securing financing or allocating cash reserves for payouts.

Partnering with a specialized TPA can simplify these steps and ensure fiduciary responsibilities are met.

Ideal For

ESOPs are best suited for profitable, closely held companies whose owners want a tax-efficient exit strategy and to reward employees with true ownership. If your business can support the transaction costs and ongoing repurchase demands, an ESOP can drive engagement while providing a structured succession plan.

10. Payroll Deduction IRA

If you run a micro-business or nonprofit and want to offer employees an easy way to save for retirement without the paperwork of a 401(k) or SEP, a Payroll Deduction IRA can be just the ticket. In this setup, your payroll system simply routes employee-elected deferrals into their own Traditional or Roth IRA accounts. It’s quick to stand up and keeps administrative overhead to a minimum.

Overview of Payroll Deduction IRA

A Payroll Deduction IRA isn’t a separate plan document under ERISA—instead, you’re helping employees fund individual IRAs through automatic payroll deferrals. Participants choose whether to open a Traditional or Roth IRA with a custodian of their choice. Once their account is established, payroll withholds contributions and sends them directly to the IRA.

Eligibility and Contribution Limits

Any employee who meets your basic employment criteria—there are no age or service thresholds beyond the IRS’s own rules—can participate. Contribution limits for 2025 mirror those for standalone IRAs:

Up to $7,000 in annual contributions.
An $8,000 limit if the participant is age 50 or older (catch-up).

Employees decide how much to defer (within those caps) and whether to split contributions between Traditional and Roth IRAs, provided their chosen custodian allows it.

Tax Treatment and Withdrawals

Traditional IRA deferrals through payroll are typically made on a pre-tax basis, reducing the participant’s current taxable income. Withdrawals in retirement are taxed as ordinary income, with a potential 10% penalty for distributions before age 59½ (unless an exception applies).
Roth IRA deferrals use after-tax dollars, so they offer no immediate deduction—but qualified withdrawals (after age 59½ and a five-year holding period) are tax-free. Early Roth distributions of contributions (but not earnings) can usually be taken penalty-free.

Pros and Cons

Pros:

No formal plan document or annual IRS filings—employer liability is limited.
Minimal setup: once employees open IRAs, payroll handles ongoing deferrals.
Allows both Traditional and Roth options, giving flexibility to savers.

Cons:

Low contribution limits compared to 401(k)s, SEP IRAs or other plans.
Employers cannot make contributions on behalf of employees.
Employee IRAs aren’t covered by ERISA, so participants miss certain protections and fiduciary oversight.

Setup & Administration

Notify employees that they can open a Traditional or Roth IRA with a custodian of their choice.
Have each participant complete the IRA application and provide account details to payroll.
Configure payroll to deduct deferrals and remit them directly to each IRA, respecting IRS contribution limits.
Maintain simple records of deferral elections and deposit dates; there’s no Form 5500 or nondiscrimination testing.

Best For

Payroll Deduction IRAs shine in tiny firms and mission-driven organizations that want a retirement perk without the cost and complexity of ERISA-governed plans. If you employ fewer than 10 people or have a tight budget, this “set it and forget it” option delivers a straightforward way for staff to save for their future.

11. 403(b) Plan

For organizations that qualify—primarily public schools, certain nonprofits under IRC Section 501(c)(3) and churches—a 403(b) plan offers a tax-favored way for employees to save for retirement. Often called a tax-sheltered annuity (TSA) or custodial account, a 403(b) combines features of a traditional 401(k) with unique catch-up provisions tailored to the education and nonprofit sectors.

What Is a 403(b) Plan?

A 403(b) plan allows eligible employees to defer a portion of their salary into either annuity contracts or custodial accounts holding mutual funds. These contributions grow on a tax-deferred basis until distribution. While some employers choose to make matching or nonelective contributions, employee salary deferrals form the backbone of most 403(b) arrangements.

Eligibility and Participation

Only employers classified as public educational institutions, 501(c)(3) nonprofits or certain ministers and church-related organizations can sponsor a 403(b). Within those entities, employees who meet the plan’s age and service requirements are eligible to enroll. Unlike many private-sector plans, nondiscrimination testing for elective deferrals generally isn’t required if only employees contribute. However, once the employer adds contributions, ERISA rules—including Form 5500 filing—may kick in.

Contribution Limits and Catch-Up

For 2025, employee elective deferrals to a 403(b) can reach up to $23,500. Participants aged 50 or older may add a $7,500 catch-up contribution. In addition, employees with at least 15 years of service at the same eligible employer can qualify for a “15-year” catch-up of up to $3,000 annually, subject to a lifetime cap of $15,000. Together, these provisions enable long-tenured workers to accelerate savings as retirement approaches.

Tax Advantages and Distributions

Contributions to a 403(b) reduce an employee’s current taxable income, and investments grow tax-deferred. Distributions taken after age 59½ are taxed as ordinary income, with a standard 10% penalty on withdrawals before that age—unless an exception applies (such as hardship, certain medical expenses or separation after age 55). Required Minimum Distributions must begin by April 1 of the year following the year the participant turns 73.

Pros and Cons

Pros:

No mandatory employer contribution—employees drive their own savings.
Two distinct catch-up options help long-service and older workers maximize contributions.
Annuity contracts can provide guaranteed income streams in retirement.

Cons:

Investment choices may be limited to insurance-company annuities or a narrow mutual fund lineup, often with higher fees.
Plan documents and compliance for ERISA-covered 403(b)s can be complex, triggering annual Form 5500 and nondiscrimination requirements if the employer contributes.
Hardship rules and loan provisions can vary by provider, adding administrative nuance.

Setup & Administration

Adopt a written plan document that satisfies IRS and, if applicable, ERISA requirements.
Select one or more approved vendors (insurance companies or mutual fund custodians) that offer 403(b) contracts or custodial accounts.
Create enrollment materials and notify eligible employees of their deferral and catch-up options.
Coordinate with payroll to handle timely salary deferrals and any employer contributions.
If the plan includes employer contributions or has more than a de minimis level of assets, file Form 5500 annually and follow any required ERISA testing protocols.

By matching the unique workforce and mission–driven goals of public and nonprofit employers, a 403(b) plan can be a highly effective retirement vehicle—so long as you balance employee needs, provider options and compliance obligations.

12. 457(b) Deferred Compensation Plan

For public-sector employers and certain nonprofit organizations, a 457(b) plan offers a valuable way to help employees defer compensation on a pre-tax basis. While it functions similarly to a 401(k) or 403(b), a 457(b) adds unique flexibility in contribution opportunities and withdrawal rules, making it an appealing option for government and eligible tax-exempt employers.

Overview of 457(b)

A 457(b) plan is a nonqualified, deferred compensation arrangement sponsored by state or local government entities and some 501(c)(3) nonprofits. Participants elect to defer a portion of their salary into the plan, where it grows tax-deferred until distribution. Because the plan is nonqualified, contributions and earnings aren’t subject to ERISA’s nondiscrimination testing, but the employer also doesn’t get the same level of safe-harbor protections.

Eligibility and Participation

Only public-sector agencies—such as municipalities, school districts and state governments—and certain tax-exempt organizations may offer a 457(b) plan. Within those employers, any employee meeting the plan’s written criteria can participate. There are no broad IRS service or age requirements beyond what the employer specifies, making it straightforward for eligible staff to enroll.

Contribution Limits and Special Catch-Ups

For plan year 2025, participants may defer up to $23,500 of their salary into a 457(b). Two special catch-up provisions can boost that limit:

Age-50 catch-up: Adds an extra $7,500 for participants aged 50 and over.
“Final three years” catch-up: Allows employees within three years of their plan’s normal retirement age to defer up to twice the annual limit (effectively $47,000 in 2025), subject to unused deferral capacity from prior years.

These options can dramatically increase retirement savings for long-serving employees nearing retirement.

Tax Advantages and Withdrawals

Contributions to a 457(b) reduce the participant’s current taxable income, and investments grow tax-deferred. Upon distribution:

Tax treatment: Withdrawals are taxed as ordinary income.
Early withdrawals: Government-sponsored 457(b) plans are not subject to the 10% IRS early-withdrawal penalty that applies to 401(k)s and IRAs. However, ordinary income tax still applies on the distributed amount.
Distribution timing: Participants may take distributions upon separation from service, retirement, unforeseeable emergencies or plan-specified dates.

Pros and Cons

Pros:

Employees can contribute to both a 457(b) and a 401(k) or 403(b) in the same year, effectively doubling their retirement deferral potential.
No 10% early-withdrawal penalty gives participants greater access to funds before age 59½ in genuine emergencies.
No nondiscrimination testing means higher-paid employees can defer more without running afoul of IRS rules.

Cons:

Only available to state/local government and qualifying nonprofit employers.
Plan document design and administration require careful attention to IRS nonqualified plan rules.
Deferred compensation creates a liability on the employer’s balance sheet, which can impact budgeting and cash-flow planning.

Setup & Administration

Plan document: Draft or adopt a compliant 457(b) plan document that defines eligibility, deferral elections, distribution events and any employer contribution policy.
Recordkeeping: Partner with a recordkeeper or TPA experienced in nonqualified plans to process deferrals, maintain participant accounts and handle distributions.
Employee communication: Provide enrollment materials and deadlines, and explain special catch-up options.
Ongoing compliance: Governmental 457(b) plans are exempt from annual Form 5500 filing, but nonprofit-sponsored plans may require it. Regularly review plan terms to ensure continued IRS compliance.

By understanding its distinctive features—especially the dual-plan contribution potential and penalty-free withdrawals—a 457(b) can be a powerful addition to the retirement-savings toolkit for public-sector and eligible nonprofit employees.

Making the Best Choice for Your Business’s Retirement Plan

Choosing among a dozen retirement vehicles can feel overwhelming, but it boils down to aligning plan features with your company’s unique profile. Start by asking:

What’s your business size and growth trajectory? Solo ventures often favor Solo 401(k)s or SEP IRAs, while larger staffs may justify a Traditional 401(k), SIMPLE IRA, or even a Cash Balance Plan.
How much can you budget for setup and ongoing administration? Simple IRAs and Payroll Deduction IRAs keep costs low, whereas Defined Benefit and ESOPs carry higher actuarial, legal, and trustee fees.
Where are you (and your key employees) in the career cycle? Owners within 10–15 years of retirement often benefit from high-limit plans like Cash Balance or Defined Benefit to accelerate catch-up contributions.
What level of administrative capacity do you have? If you’d rather avoid annual Form 5500 filings and nondiscrimination testing, lean toward plans with minimal IRS reporting, such as SEP IRAs or SIMPLE IRAs.
How do your employees save? Plans with employee deferrals (401(k)s, 403(b)s, 457(b)s) empower staff to build their own nest egg, while Profit Sharing and ESOPs let you drive contributions based on profitability or company ownership.

There’s no one-size-fits-all solution. Weigh the trade-offs—contribution limits, tax advantages, compliance burdens—and lean on experts when needed. A brief consultation can clarify complex areas like ERISA fiduciary obligations or startup tax credits, ensuring you pick a plan that serves both your business goals and your team’s financial futures.

To streamline administration, stay ERISA-compliant, and potentially reduce costs, consider partnering with Summit Consulting Group, LLC. Discover how Summit Consulting Group, LLC can tailor the right retirement strategy for your organization and handle the heavy lifting—so you can focus on growing your business.