Going into business for yourself has a lot of perks, and it also has a few drawbacks. You’re responsible for every detail, and that includes your own retirement. The younger you are, the more retirement bang you get for your buck, so start as early as possible.
Several retirement options are available for small business owners. Choose a plan based on the size of your business, whether you have employees to consider, and how much money you plan to save. Here are several plans to consider.
1. Simplified Employee Pension Plan (SEP-IRA)
As both the employer and an employee, a SEP-IRA plan has some distinct advantages, but only if you are committed to providing a pension for all future eligible employees. If your staff grows, this plan does not allow for exclusions. Eligible employees are over 21 (you can choose to include younger employees), and have been paid more than $600 for at least three of the last five years. All work counts. If they start in mid-December, or if they are seasonal and only work a few weeks during the year, it counts as a full year if they earn more than $600.
The advantage of a SEP for an owner-only or small family business is the amount of money you can set aside, and the ease of getting started. There is no government paperwork requirement, and no expense to set it up.
You can contribute up to $56,000, or 25% of your net compensation, which is defined by the IRS as your net earnings from self-employment, reduced by one-half of your self-employment tax plus your entire SEP-IRA contribution, calculated up to a compensation limit of $280,000 in 2019.
You can save even more with a traditional IRA at the same time, which builds your retirement nest egg and reduces your taxable income.
SEP-IRAs are very flexible; there is no set amount you have to contribute. During bonus income years, you can max it out, and if you can’t afford to put money away in any given year, you don’t have to.
2. Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRA
The SIMPLE IRA is a good small business retirement plan for a company with 100 or fewer employees. The most appealing aspect of this plan is simplicity compared to a traditional 401(k). No government filing is required and calculations are straightforward.
As the employer, you can contribute in one of these ways:
- You can make a dollar-for-dollar matching contribution up to 3% of the employee’s compensation. If you choose this contribution and you have a particularly lean year, you can limit your contribution to 1% for two out of five years, as long as you notify employees in advance.
- Or you can make a 2% nonelective contribution for each eligible employee. With the “nonelective” contribution formula, even if an eligible employee doesn’t contribute, you must contribute 2% of their compensation up to $280,000 for 2019.
Employees can contribute $13,000 in 2019, but they don’t have to. With a SIMPLE IRA, employees can have more than one retirement plan.
The drawbacks to this plan are lower contribution limits and inflexible contributions. Loans are not allowed.
3. Savings Incentive Match Plan for Employees (SIMPLE) 401(k)
The contribution rules for SIMPLE 401(k) is somewhere between a 401(k) plan and a SIMPLE IRA, with similarities to both. It’s designed for businesses with fewer than 100 employees. Contributions are limited to $13,000 in 2019.
The most significant difference between the two types of plans is that the SIMPLE 401(k) allows loans from the plan.
401(k) plans offer tax advantages for employers and employees. Contributions are deductible within limitations, and under current laws, capital gains are not taxed until distribution.
4. Solo 401(k) plan
If you’re a solopreneur or a small partnership, and your business will never require employees, a Solo 401(k) plan, also known as a One-Participant 401(k), might be the right way to build a successful retirement plan.
This plan is a traditional 401(k) plan for individual business owners, and you can maximize deductions by contributing to your retirement account as both employer and employee.
You also have a considerable tax advantage. You can take elective contribution deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) as long as it does not exceed the annual contribution limit, which is $19,000 in 2019, or $25,000 in 2019 for people age 50 and over.
In addition, with your employer hat on, you can make nonelective contributions up to 25% of compensation. While calculations can be a bit tricky, if you’re committed to saving a big chunk of your income, this is a great way to do it. Bear in mind, when you hit $280,000 (for 2019) in savings, you must file paperwork.
The Sad State of Small Business Retirement
The number of small business owners who don’t save for retirement is shocking. Recent independent studies by Manta and SCORE found that 34% to 40% of small business owners have no retirement money socked away, and no plans to retire. Paychex found that only 20% of small business owners said they felt “very confident” that they'll have the funds to retire comfortably.
No matter where you are in your career, it’s time to save for retirement. The earlier you start, even if it’s with a small amount, the more comfortable you’ll be when you’re finally ready to explore your bucket list.