Retirement Plans For Small Business Owners

Published May 19th, 2022

Reading Time: 8 minutes

Small Business Retirement Plans

Written by:

John Bovard, CFP®, EA
Zoe Network Advisor

 As business owners, we live in our business day and night. We put in as much work and time needed for it to thrive, and we’re so wrapped up in the day-to-day of the business that we can forget to think long-term.

The Role of Small Business Retirement Plans

Embarking on the rocketship of starting a business is both exhilarating and overwhelming. Your business becomes your baby, and sometimes, you have to take care of it for a while with little-to-no money, help, or allies. It requires an admirable level of fearlessness, passion, and dedication. 

The thing is… when we’re dedicating so much time and effort to something like our own business, we tend to expect (and wish for) something in return. Most of the time, money. 

Running a small business in its early days sometimes means having a “workaholic” mentality that gives us permission to push aside our work-life balance. As business owners, we live in our business day and night. We put in as much work and time needed for it to thrive, and we’re so wrapped up in the day-to-day of the business that we can forget to think long-term. 

I often hear this phrase from my small business owner clients: “Eventually, the hard work will pay off, and I’ll be able to have a stress-free future!” 

What if I told you there’s no need to sacrifice your personal life, or future, for your business? Maybe you wouldn’t believe me. But what I can assure you is that your retirement isn’t (or shouldn’t be) dependent on the success of your business; it’s dependent on how well you plan for it. 

For most business owners, retirement comes from a financial windfall that awaits them along the road. Although sometimes, this is the case, it’s not safe to rely on a successful business transaction to fund your retirement. However, you can take advantage of several small business retirement plans. 

Small business retirement plans are key to securing and protecting your retirement. There are many options to choose from, whether that is a small business 401k, Simple IRA, SEP-IRA, or even a solo 401k. The choices are out there, and it’s essential to get one established so that your nest egg can be used to fund your retirement without relying on something else (like a windfall). 

Small Business Retirement Plans For Business Owners 

The overall benefits of small business retirement plans are that they allow the owner to reduce their current income, defer taxes on their investment gains, diversify from their business equity and retain talented employees. Here are some of the options, along with the advantages and disadvantages. 

Small Business 401k 

The 401k is the most common retirement plan. A 401k allows you to contribute directly from your paycheck on a pre-tax (or Roth) basis. This money is deducted before it reaches the net income amount and before savers can access it. This contribution reduces your gross income for the year, therefore shielding that amount from taxes. The money can then grow tax-deferred until it’s withdrawn for retirement. The funds will be taxed as ordinary income at the time of withdrawal.

The main advantage is that it allows you to contribute the greatest amount to your retirement plan. You can also contribute from your paycheck, as well as a company match and a profit-sharing contribution. For the year 2022, the maximum amount a plan participant can contribute to their plan is $20,500; workers over the age of 50 can contribute an additional $6,500 catch-up contribution. In addition to these amounts, the owner can match a percentage of the contributions and choose to make a discretionary profit-sharing contribution.

The disadvantages? For smaller businesses, the administration and costs of a 401k plan may outweigh the benefits. With the benefits of a 401k plan come the responsibilities of the plan trustees. Plan trustees are also known as plan fiduciaries and have the role of providing the best plan possible to their employees. Several rules regarding the 401k plan are nondiscrimination testing, timely plan disclosures, diversified fund menu, and lowest share class menu, among others. If a plan doesn’t pass specific testing requirements, the highly compensated employees, including the owner, may not be able to make the maximum contribution to the plan. Also, based on the size of the plan, the expenses could range from $5,000 on the low end to $20,000 all-in costs on the high end.  

Simple IRA For Small Business

Simple IRAs are an excellent solution for companies with two or more employees looking to lower costs and reduce administrative burden. 

The main advantage of a Simple IRA is that the investment options are limitless and can include individual securities and Exchange Traded Funds. In addition, simple IRA plans can be set up at the majority of the large brokerage firms for no cost. Like a 401k plan, within a Simple IRA, you can make tax-deductible contributions, accounts grow tax-deferred, and at retirement, they can be withdrawn tax-free. 

Two disadvantages come along with these accounts. The first one is the Simple IRA has a lower maximum contribution amount. In 2022 the maximum contribution is $14,000 for participants under 50 plus an additional $3,000 for those over 50. The second disadvantage is that the match is mandatory for employers. Unlike a 401k plan where the match is discretionary, a Simple IRA requires a 3% match and cannot offer lower than a 1% match for more than 2 out of 5 years. 

Retirement Sep IRA 

A SEP IRA is an excellent solution for individuals that own or are self-employed. SEP stands for Simplified Employee Pension. Notice that the definition of self-employed includes independent contractors that would be eligible to contribute to a SEP IRA. Like a Simple IRA, you can open a SEP IRA at large brokerage firms for no fee. A SEP IRA also has investment flexibility and allows you to invest in individual securities. 

I typically recommend a SEP IRA for businesses with only one person, i.e., the owner. This is because there are no employee contributions to the plan. Instead, the only contributions to the SEP are from the employer. Therefore, all contributions need to be the same for each employee. As of 2022, the maximum contribution you can make to a SEP IRA is 25% of net earnings up to a maximum of $61,000. 

Solo 401k Plans

An additional option for small business retirement plans is solo 401k plans or a one-participant 401k. The solo 401k plan has the same contribution limit as a regular 401k plan. However, with the solo 401k, the owner acts as both the employee and the employer when making contributions. 

For example, the owner can contribute $15,000 into their plan as an employee and then an additional $15,000 as an employer profit sharing contribution. In addition, if a business owner is married, their spouse can join the solo 401k plan. Unlike a SEP IRA, this is a unique benefit to the solo 401k. 

Wrapping up Small Business Retirement Plans

Business owners believe they need to pour every last dollar into their business, hoping that the money will grow along the road. However, if you want a safe nest egg to fund your retirement without being dependent on the success of your business, you need a plan B. A vetted wealth planner can help you find the best retirement account for your goals while building a solid financial plan that will give you peace of mind. Plus, more stress-free time to dedicate to your business! 

You shouldn’t wait for your business to be successful enough to fund your retirement. Having a retirement plan early on will allow you to have peace of mind knowing your golden days are still golden. If you receive a windfall from the success of your business, you can do whatever you want with it; Pay for your kids’ education, buy your dream home, take a well-deserved vacation, and build up your legacy! 

This blog is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.

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