IRS Pub. 560: Retirement Plans for Small Business

IRS Publication 560 is a guide for small business owners and self-employed individuals on retirement plans. This IRS document provides the rules and guidelines for establishing and maintaining a compliant retirement savings program. It addresses selecting an appropriate plan, understanding contribution limits, and navigating tax implications.

This article clarifies the options available, the steps for implementation, and the ongoing responsibilities of sponsoring a retirement plan. The focus is to provide a clear path for making informed decisions that align with business objectives and financial security for owners and their employees.

Understanding Your Plan Options

Choosing a retirement plan requires matching its structure to your business’s size, profitability, and administrative capacity. The options in Publication 560 cater to various small business scenarios, from sole proprietors to companies with up to 100 employees. A primary consideration is whether the plan will be funded solely by the employer or will also allow for employee contributions.

Some plans are designed for simplicity and minimal administration. Others offer higher contribution limits and more features but come with more stringent regulatory requirements.

SEP Plans

A Simplified Employee Pension (SEP) plan allows employers to make contributions toward their own and their employees’ retirement. The employer establishes a SEP-IRA for each eligible employee and makes tax-deductible contributions to it. Only employer contributions are permitted, as employees cannot contribute through payroll deductions. This plan is well-suited for those who want a low-cost, easy-to-administer option with flexible contribution amounts.

SIMPLE Plans

The Savings Incentive Match Plan for Employees (SIMPLE) IRA is for businesses with 100 or fewer employees. Unlike a SEP, a SIMPLE IRA allows contributions from both the employee and the employer. Employees can contribute a portion of their salary, and the employer is required to make either a matching or a non-elective contribution. The employer’s contribution is mandatory, providing a consistent benefit for participating employees.

Qualified Plans

Qualified plans are a more complex category that must meet detailed requirements of the Internal Revenue Code, often offering higher contribution limits and greater design flexibility. They require a formal plan document and more involved annual administration. There are two main types: defined contribution plans and defined benefit plans.

A defined contribution plan, such as a 401(k) or profit-sharing plan, specifies the contributions made to individual accounts. The final retirement benefit depends on contributions and investment performance. A 401(k) plan allows employees to defer a portion of their salary, often with an employer match.

A defined benefit plan promises a specific monthly benefit to employees at retirement based on factors like salary and years of service. An actuary must calculate the annual contributions required to fund the promised benefits, making these plans more complex and costly to maintain.

Establishing a Retirement Plan

To establish a retirement plan, you must formally adopt it by the end of the business’s tax year for which the plan is to be effective. A foundational requirement is a formal written document that outlines its terms and governs its operations. The IRS provides model plan documents, such as Form 5305-SEP for SEP plans, which can simplify the setup process.

For a SIMPLE IRA plan, an employer can use either Form 5304-SIMPLE or Form 5305-SIMPLE. The choice depends on whether employees can select their own financial institution or if the employer designates one for all contributions. These model forms are not filed with the IRS but are kept as part of the business’s records.

To complete the setup, a business owner will need to gather specific information, including:

• The business’s legal name, address, and Employer Identification Number (EIN)
• Each eligible employee’s full name
• Each eligible employee’s date of birth
• Each eligible employee’s Social Security number
• Each eligible employee’s compensation details

Contribution Rules and Limits

The amount that can be contributed to a retirement plan each year is governed by specific IRS rules and limits. For employees, compensation is the pay they receive from the employer for the year. For a self-employed individual, the calculation starts with net earnings from self-employment, which must then be reduced by one-half of the self-employment tax and the contribution made for oneself.

For most plans, employer contributions for a specific tax year can be made up until the due date of the business’s federal income tax return, including extensions.

SEP Plan Contributions

For a SEP plan, only the employer makes contributions. The amount contributed for each employee is limited to the lesser of 25% of the employee’s compensation or $69,000 for 2025. The employer has flexibility in the contribution amount each year, but the contribution percentage must be the same for all eligible employees, including the business owner.

SIMPLE Plan Contributions

SIMPLE IRA plans involve contributions from both employees and the employer. For 2025, employees can make salary deferral contributions up to $16,000, and individuals age 50 and over can make an additional catch-up contribution of $3,500. Employers must contribute through one of two methods: a dollar-for-dollar match up to 3% of the employee’s compensation or a non-elective contribution of 2% of compensation for all eligible employees.

Qualified Plan Contributions

Qualified plans like 401(k)s have more complex contribution structures. For 2025, an employee can defer up to $23,000 of their salary into a 401(k), and those age 50 and over can contribute an additional $7,500 as a catch-up contribution. The overall limit for total contributions to a defined contribution plan, including all employee and employer amounts, is the lesser of 100% of compensation or $69,000 for 2025.

Plan Administration and Maintenance

Once a plan is established, the business owner has ongoing administrative responsibilities to keep the plan in compliance. This includes providing clear and timely information to all eligible employees about the plan’s terms and their rights. This communication includes a copy of the summary plan description when an employee becomes eligible and annual notices regarding contributions and plan features.

Annual Reporting

Certain retirement plans must file an annual report with the federal government on the Form 5500 series. Plans with 100 or more participants file Form 5500, Annual Return/Report of Employee Benefit Plan. One-participant plans may be able to file the simpler Form 5500-EZ. SEP and SIMPLE IRA plans are not required to file a Form 5500. The filing deadline is the last day of the seventh month after the plan year ends.

Distributions and Rollovers

Plan administrators are responsible for processing participant distributions according to the plan’s terms and legal requirements. When a participant takes a distribution, the administrator must apply the proper tax withholding and report the distribution to the IRS and the participant on Form 1099-R. Participants often have the option to roll over their account balance to another retirement plan or an IRA, and the administrator must provide a notice explaining these options.

Prohibited Transactions

Plan sponsors and other fiduciaries are subject to rules that prohibit certain transactions between the plan and a “disqualified person,” which includes the business owner and other fiduciaries. Prohibited transactions include borrowing money from the plan, selling property to the plan, or using plan assets for personal benefit. Engaging in such a transaction can result in penalties, including excise taxes.

Plan Termination

If a business decides to terminate its retirement plan, it must follow a formal process. This includes amending the plan document to reflect the termination date and providing notice to all participants. All participants become 100% vested in their account balances upon termination. The plan assets must then be distributed, and for certain qualified plans, a final Form 5500 must be filed.