With the many day-to-day concerns of the average business owner, saving for their own retirement can get pushed to the side and forgotten. After all, unlike their employee counterparts, the self-employed do not have immediate access to the simple and largely automated savings plans set up by most corporate employers.
However, with a little time and effort business owners can develop their own plan for retirement. There are several options available to entrepreneurs that provide flexibility, tax advantages, and allow for significant contributions.
TRADITIONAL AND ROTH IRA
An IRA is technically an individual retirement plan, and therefore not exclusive to the self-employed. Nonetheless, it can be a great starting point for entrepreneurs looking to stay on track for retirement. An IRA is easy to open and allows for contributions of up to $6,000 per year ($7,000 if age 50 or older) for tax year 2020.
IRAs come in two varieties: Traditional and ROTH.
Traditional IRA contributions are considered tax-deferred accounts. Contributions are tax deductible in the present with taxes paid in retirement at the time of distribution.
ROTH IRA contributions are made with after-tax contributions but provide the significant benefit of tax-free growth and tax-free withdrawals in retirement. This makes a ROTH IRA a great option for those in a lower tax bracket today and expect their earnings to increase with time.
Note there are income limitations for the ROTH options, which may require proactive planning with your accountant or financial planner.
Given the simplicity and relatively low contribution limits, IRAs are a valid option for solopreneurs, freelancers, or those in their first years of starting a business. Business owners looking to ramp up their savings should look to the following plans.
SOLO 401(K)
A solo 401(k) is a great option for entrepreneurs looking to save more than $6,000 or $7,000 per year and who have no employees.
Perhaps the greatest benefit of a Solo 401(k) is the ability to contribute a significant amount of money towards retirement and the flexibility to adjust contributions from year-to-year depending upon cash flow and income.
Like a normal 401(k), there are employer and employee contribution limits. Since this is a solo plan, the business owner acts as both employer and employee.
Employee contributions are limited to $19,500 (plus an additional $6,000 if age 50 or older) in 2020. Additionally, the business may contribute up to 25% of compensation.
The total combined contribution cap is the lesser of 100% of earned income or $57,000 ($63,000 if age 50 or older).
An added benefit is the common availability of Roth 401(k) options inside of a solo 401(k). Such a plan structure provides the same tax-advantaged benefits as a ROTH IRA, but with the higher contribution limits outlined above.
A solo 401(k) plan is a terrific option for high-earning solopreneurs or freelancers that have progressed beyond what the IRA provides but are not looking for larger plan options as a benefit for their employees.
SEP IRA
A SEP IRA is a good alternative to the solo 401(k) for businesses with no or very few employees. It has similar contribution limits as a solo 401(k) but also allows the business to provide a retirement option for non-owner employees.
For tax year 2020, the same contribution limit as the solo 401(k) applies. Contributions may not exceed the lesser of $57,000 or 25% of compensation.
One disadvantage of a SEP IRA is the potential cost. The plan requires that equal contributions be made for all eligible employees. For example, if an owner wishes to save five percent of their earnings through contributions to the plan, the company must contribute the same five percent for all eligible employees.
Only employer contributions are allowed, meaning employees cannot pay into the plan. There is also no ROTH option with a SEP IRA.
The SEP IRA, while potentially more costly comes with less administrative burden than a solo 401(k). It also offers the small but growing business owner an option to provide a plan that may potentially retain or attract talent.
SIMPLE IRA
A SIMPLE IRA is intended for slightly larger businesses with up to 100 employees.
Unlike a SEP IRA, employees can also make contributions to the plan. Employees may make contributions of $13,500 for tax year 2020 ($16,500 if age 50 or older).
Like a SEP IRA, the SIMPLE can be costly. Employers are generally required to make matching contributions for employees up to 3% or fixed contributions of 2% to all eligible employees.
Like a traditional 401(k) or traditional IRA, contributions are tax deductible in the present. However, distributions taken at retirement will be taxed at that time.
With combined employer and employee contributions, a SIMPLE IRA makes for a solid plan for business owners that are beyond the startup phase and looking for better retirement plan options for themselves and their employees.
TAKING ACTION
For the most part each of these retirement plans can be setup relatively quickly and with little initial cost. If you would like to explore retirement plan options further, contact us to start a conversation today.
Additionally, Financial Planning is only one aspect of a business owner’s universe. A truly holistic plan combines financial (retirement) planning with personal goals and value creation within the business.