Retirement Plan Options for Solo and Small Law Firms

Even though you do not have an employer-sponsored retirement plan as a solo practitioner or shareholder in your small firm, you still have retirement options. Being a sole practitioner or small-firm shareholder gives you the ability to choose the kind of retirement plan that is right for you and your business.

There are three main options:

Keep in mind that there is no “one size fits all” solution. Each plan has advantages and disadvantages, which are outlined below. Before you make any actual decisions about which plan is right for you, I highly recommend you get advice from an accountant, investment adviser, or certified financial planner. This post is intended to give you an overview of the advantages and disadvantages of each available option.

SIMPLE IRA

SIMPLE stands for Savings Incentive Match Plan for Employees. This type of plan is designed to give small employers and their employees a simple method for making retirement contributions. Each participant’s contributions go into their own IRA(s) set up in the plan. This plan can be set up by employers, sole proprietorships, and partnerships.

Advantages

• SIMPLE IRA plans are reportedly easy to set up, and allow your employees the choice of whether or not to contribute. As with all three of the plans listed here, the employee can select a variety of mutual funds as investment vehicles for the plan.
• Allow for catch-up contributions.
• Contributions to the plan do not count toward the individual IRA contribution limit.
• Contributions are pre-tax.

Disadvantages

• As the employer you are required to provide a matching contribution of either 2% or 3%, depending on the employee’s deferral.
• The contribution limit is $12,000 as of 2014, the lowest of any of these options.
• If you have more than 100 employees who individually earned more than $5,000 in the previous year your business is ineligible for participation.

SIMPLE IRA Resources

• IRS Checklist for Simple IRAs
• IRS Video Guide to SEP and SIMPLE Plan set-up

SEP IRA

SEP stands for Simplified Employee Pension plan. It is funded entirely by employer contributions as a percentage of compensation. This type of plan is available for any size business. In this type of plan, only the employer makes contributions to the plan. The contributions for each employee go into their own IRA(s) set up in the plan.

Advantages

• The contribution limit is higher than the SIMPLE option: 25% of earnings or $52,000 as of 2014, whichever is less.
• Contributions by the employer are deductible as a business expense.
• Contributions to the plan do not count toward the individual IRA contribution limit.
• Contributions to the plan do not count as yearly income for the employee.

Disadvantages

• A SEP IRA can only be funded by employer contributions. This means that you cannot lower your taxable income by contributing to the plan, as you would in a 401k.
• The contributions max out at 25% of the employee’s W-2 earnings or $52,000 as of 2014, whichever is less.
• If you have any eligible employees¹, they must also participate in the plan. The percentage of W-2 earnings must be uniform across all employees, meaning that if you as business owner give yourself 25% of your W-2 earnings, your employee must receive 25% as well.
• SEP IRA’s do not allow catch-up contributions.
• If you own a controlling interest in another business, the employees of that business could be required to participate in the SEP IRA of your law firm as well.

SEP IRA Resources

• IRS Checklist for SEP IRAs

Individual 401k

Individual 401k plans work pretty much the same way as larger company 401k plans, but with some advantages for the business owner with no employees. This type of plan is only for sole proprietors or partnerships with no employees. This type of plan can be set us as a traditional 401k² or as a Roth 401k³.

Advantages

• As a business owner you essentially wear both the “employee” and “employer” hats in making contributions. As employee you can contribute up to $17,500 of your W-2 income as of 2014, and thus lower your tax burden. As employer you can then match up to 25% of your W-2 compensation. Total contributions cannot exceed  $52,000 as of 2014.
• Contribution limit is higher than the SIMPLE option at $52,000.
• Allows for “catch-up” contributions.
• Contributions to the plan do not count toward the individual IRA contribution limit.
• You can elect to have a portion of your employee contributions be converted into a Roth 401k.
• If you have an existing 401k from your prior employer you can roll it over into an Individual 401k without it becoming a taxable event.

Disadvantages

• Only businesses that have no full-time employees or part-time employees that worked more than 1,000 hours in the past year can participate. The spouse of the business owner does not count as an employee.
• This option seems to be the most difficult to set up and administer. It also requires the filing of an IRS form 5500.

Individual 401K Resources

• IRS Guide to One-Participant 401k Plans

Further Reading

Schwab, Vanguard, Fidelity, and ETrade all have guides to setting up small business retirement accounts. If you already have an account with a brokerage firm that offers small business retirement services, I would strongly suggest sitting down with an adviser and going through everything with them. They will be eager to help you out if you are looking to establish a plan with them.

Again, there is no “one size fits all” solution, and you should take into account the tax implications of any decision. Talk with a professional before deciding on anything. Find out what fees your brokerage firm charges in administering each plan. If you have experience with any of these plans, please share your thoughts in the comments.

Originally published 2014-12-16. Republished 2019-12-16.

1. “Eligible” is defined by the IRS as someone who is at least 21 years of age, was employed by you for 3 of the immediately preceding 5 years, and received compensation from you of at least $550. ↩

2. Contributions are pre-tax and taxed when distributed later. ↩

3. Contributions are post-tax and not taxed on distribution. ↩

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