The IRS code is quite literal in how it defines the different types of retirement plans. In Defined Contribution plans, IRS code set limits on the maximum amount that can be contributed each year. In Defined Benefit plans, the rules set limits on the benefits – or the maximum amount that the plan can pay out in retirement. Under these sets of rules, a number of different plans have been developed. The ones most frequently used for small businesses are:
- Defined Benefits Plans such as traditional Defined Benefit and Cash Balance plan.
- Defined Contribution Plans such as SIMPLE IRA, SEP-IRA, Individual 401(k)/Profit Sharing, Regular 401(k) or Safe Harbor 401(k)/Profit Sharing
2023 plan maximum contribution limits*
for a 52 year old, including “catch-up” contributions of $3,500 for SIMPLE IRA, $7,500 for 401(k).
Key Differences Defined Benefit Plans vs. Defined Contribution Plans
Defined Benefit Plans
- Larger contributions allowed on behalf of business owner (depending on a number of factors)
- Business funds contributions on behalf of employees
- Contributions generally are required each year
Defined Contribution Plans
- Limited contributions on behalf of business owner
- Plans are funded by business owner but employees have the option to contribute for themselves
- Annual contributions generally are not required
Compare Retirement Plans for a Small Business
- Defined Benefit
- High income self-employed individuals, owner + spouse or family businesses that want to maximize tax savings with large, tax-deferred contributions. This plan may be combined with an individual 401(k) plan to increase contribution and flexibility.
- Individual 401(k)/Profit Sharing
- Self-employed individuals, owner and spouse, or family businesses that want optional contributions. This plan is not suitable for a business if there are non-family employees.
- SEP IRA
- Self-employed individuals and business owners who want the option to make contributions for all employees
- SIMPLE IRA
- Business owners who want an easy way to make small contributions on behalf of employees
- Cash Balance Defined Benefit
- Owners of profitable small businesses who want large deductible contributions for themselves and are willing to make limited contributions for employees. A Safe Harbor 401(k)/Profit Sharing plan often is combined with a cash balance plan. This allows the business owner to increase their contribution and control the cost of providing retirement benefits for employees.
- 401(k)/Profit Sharing
- Small and large businesses that want employees primarily to fund their own retirement.
- Defined Benefit
- There are no specified limits on the contribution. An individual’s contribution is calculated and cannot exceed the amount required to pay a specified benefit in retirement. For 2023, the annual benefit limit is $330,000.
- Individual 401(k)/Profit Sharing
- $73,500
- SEP IRA
- $66,000
- SIMPLE IRA
- $14,000 in employee deferrals for 2023. With matching contribution, maximum contribution is $28,900
- Cash Balance Defined Benefit
- There are no specified limits on the contribution; the limit is on the allowable benefit at retirement. For 2023, the annual benefit limit is $330,000.
- 401(k)/Profit Sharing
- $73,500
- Defined Benefit
- Depends on several factors including income, age, years of service. Contributions can be as high as 100% of compensation for sole proprietors; in some cases, for corporations, can exceed 100%. The benefit limit is 100% of compensation (up to $330,000), reduced pro rata for years of service less than 10. – This limit is further reduced actuarially if benefits begin prior to age 62 – This limit is increased actuarially for benefits beginning after age 65. For this reason, contributions for older participants can be much higher.
- Individual 401(k)/Profit Sharing
- For 2023, 100% of net income up to the maximum of $20,500 may be contributed in salary deferrals. In addition, a profit sharing contribution of up to 25% of net income may be made for a combined total contribution not to exceed $66,000.
- SEP IRA
- For 2023, up to 25% of compensation or $66,000, whichever is less, may be contributed. Employee deferrals are not allowed. Employer contribution percentage must be the same for all eligible employees.
- SIMPLE IRA
- For 2023, employees may contribute up to the maximum of $14,500 or 100% of income, whichever is less, in salary deferrals. In addition, the employer may make a matching dollar for dollar contribution up to 3% of compensation.
- Cash Balance Defined Benefit
- Similar to defined benefit plans, the cash balance contributions depends on several factors including income, age, years of service. Contributions can be as high as 100% of compensation for sole proprietors and in some cases, for corporations, can exceed 100% of compensation. When combined with a Safe Harbor 401(k)/Profit Sharing plan, the contributions for owners may be higher while contributions for employees are limited.
- 401(k)/Profit Sharing
- For 2023, 100% of compensation up to the maximum of $20,500 can be contributed in salary deferrals by the employees. In addition, employers may make a profit sharing contribution up to 25% of employee’s compensation for a combined total contribution not to exceed $66,000. For Safe Harbor plans, compliance testing is required to determine employer contributions.
- Defined Benefit
- Generally, yes
- Individual 401(k)/Profit Sharing
- No
- SEP IRA
- No, however if employer makes a contribution in a particular year, then contributions are required for all eligible employees for that year.
- SIMPLE IRA
- Yes, employers must make either matching or non-elective contributions for all eligible employees.
- Cash Balance Defined Benefit
- Yes
- 401(k)/Profit Sharing
- No, however if employer makes a contribution in a particular year, then contributions are required for all eligible employees for that year. For Safe Harbor plans, contributions are required each year to comply with IRS regulations.
- Defined Benefit
- The potential to allow the largest tax deductible contribution for the business owner
- Individual 401(k)/Profit Sharing
- Self-employed individuals and owner-only businesses can make discretionary contributions annually, larger than a SEP IRA allows.
- SEP IRA
- Self-employed individuals and employers can make discretionary contributions annually. The plan can be set up after tax year ends and requires no government reporting by the employer.
- SIMPLE IRA
- Allows employees to make deferrals for themselves. Simple to setup with no government reporting required by the employer.
- Cash Balance Defined Benefit
- Has the potential to provide larger tax deductable contribution for owners than any other retirement plan while providing greater control in determining the employer’s contributions for employees.
- 401(k)/Profit Sharing
- Allows employees to make salary deferrals for themselves and employers to make contributions on behalf of employees
- Defined Benefit
- To allow enough time for due diligence, the plan should be opened by year-end. However, the SECURE Act currently allows the employer to adopt the business’ tax filing deadline, including extensions.
- Individual 401(k)/Profit Sharing
- Plan should be opened by fiscal year-end, usually December 31
- SEP IRA
- Plan should be opened by the employer’s tax filing deadline, with extensions
- SIMPLE IRA
- October 1 for the current tax year
- Cash Balance Defined Benefit
- To allow enough time for due diligence, the plan should be opened by year-end. However, the SECURE Act currently allows the employer to adopt the business’ tax filing deadline, including extensions.
- 401(k)/Profit Sharing
- Plan should be opened by fiscal year-end, usually December 31.
- Defined Benefit
- Contributions are due at the tax filing deadline, with extensions but in no case later than 8.5 months after the fiscal year-end
- Individual 401(k)/Profit Sharing
- Salary deferrals are due within 15 days of year end for Corporations. Profit sharing contributions are due at the tax filing deadline, with extensions, but in no case later than 8.5 months after the fiscal year-end.
- SEP IRA
- Contributions are due by the business’s tax filing deadline, with extensions
- SIMPLE IRA
- Employee salary deferrals from the last pay check or by year-end. Employer contribution due at tax filing deadline, with extensions
- Cash Balance Defined Benefit
- Contributions are due at the tax filing deadline, with extensions, but in no case later than 8.5 months after the fiscal year-end.
- 401(k)/Profit Sharing
- Salary deferrals are due within 15 days of year end for corporations. Profit sharing contributions are due at the tax filing deadline, with extensions, but in no case later than 8.5 months after the fiscal year-end.
- Defined Benefit
- One trust account is setup for the plan which is a pooled investment account
- Individual 401(k)/Profit Sharing
- A trust account is setup for the plan
- SEP IRA
- Individual accounts are set up for each eligible employee
- SIMPLE IRA
- Individual accounts are set up for each eligible employee
- Cash Balance Defined Benefit
- One trust account is set up for the Cash Balance plan which is a pooled investment account. If a Safe Harbor 401(k) Profit Sharing plan is opened with the Cash Balance plan, individual 401(k) accounts are set up for each eligible employee.
- 401(k)/Profit Sharing
- Individual accounts are set up for each eligible employee