Our UK clients are accustomed to requirements that they contribute minimum amounts to their employees’ pensions.

It therefore often comes as a surprise that in the US there is no legal requirement that employers contribute to an employee retirement plan. The only requirements are those imposed by state governments – typically, but not always, on companies with more than five employees in their state – that employers make available opportunities for employees to contribute to a retirement scheme with no required employer contribution.

Despite this, roughly half of all private sector US employees participate in an employer-sponsored pension scheme. The labor market for highly skilled workers usually demands it. Small companies almost always offer a defined-contribution plan in which the retirement benefit is based on the contribution amount rather than the benefit amount, with the employee bearing the investment risk. Here are several options:

1. 401(k). Named after the section of the tax code under which it is authorized, a traditional 401(k) is a type of retirement plan to which the employee contributes on a pre-tax basis and the employer typically (but not always) matches the employee’s contribution up to a percentage of gross compensation. Under a 401(k), employees enjoy higher contribution limits than other forms of plans, with contributions capped at $23,000 in 2024 (or $30,500 for employees 50 and older). To avoid non-discrimination testing (under which plans are scrutinized to see whether more highly compensated employees participate or contribute at higher rates), companies typically elect to establish “safe harbor” plans, which require employer contributions of certain percentages. Under the most common safe harbor plan, the employer contribution is capped at a percentage between 4% and 6% (inclusive) of wages. As an alternative to a “traditional” 401(k), some employees are given the option to contribute to a “Roth” 401(k). Contributions to a Roth 401(k) are made on an after-tax basis, but the funds are withdrawn tax-free in retirement.

2. SIMPLE IRA. Although a 401(k) is undoubtedly the most popular defined contribution scheme, it can be complex and expensive to administer. As its name implies, a Simple IRA offers an easier and cheaper alternative. It is available for small businesses with under 100 employees. Under a Simple IRA, employees can make pre-tax contributions of up to $16,000 in 2024 ($19,500 if 50 or over). The employer is required to either, (a) match the employee’s contribution up to 3% of compensation; or (b) make a contribution equal to 2% of pay (regardless of whether the employee contributes. Many brokerage firms (e.g., Fidelity and Schwab) will permit the creation of a Simple IRA at no cost to the employer. Recently enacted legislation permits the use of a Roth version of the Simple IRA.

3. SEP IRA. Short for “simplified employee pension,” a SEP IRA is also a simplified and inexpensive form of employer provided retirement account. Unlike the 401(k) or the Simple IRA, a SEP IRA is funded exclusively by employer contributions. Each year, the employer decides how much to contribute, ranging from 0% to 25% of employee compensation (up to a maximum contribution of $69,000 in 2024). As with the Simple IRA, employers can usually establish SEP IRA accounts at no charge. Both Fidelity and Schwab offer excellent options. In addition, recently enacted legislation permits the use of a Roth version of the SEP IRA.

Keep in mind that what you offer to one employee you must offer to all employees who are eligible to participate in the scheme. For a 401(k), for example, eligible employees include any employee who works more than 1,000 hours in a year or more than 500 hours in each of two consecutive years. Different eligibility rules apply to a Simple IRA and a SEP IRA.