Retirement Planning for Small Business Owners

As a business owner, much of your attention is devoted to the day-to-day operation of your business. Thoughts of retirement may be hazy at best; after all, you’ve got far too much to do right now to focus on the future. You may even joke that you don’t ever plan to retire. 

But the reality is that small business owners need to think about retirement planning as much as, if not more than, anybody else. Not only do you not have a retirement plan provided by a company that employs you, but if you want to attract quality employees of your own, a good retirement plan is a powerful draw. Here’s a quick rundown of retirement plans for small business owners to get you started.

Retirement Planning for Small Business Owners With Employees

Business owners who have employees benefit their team as well as themselves by creating a retirement plan for their organization. There are a variety of types of retirement plans for small business owners, each with its own advantages and disadvantages to consider. 

We are often asked, “What are the best retirement plans for small business owners?” The answer is, “The one that best meets your needs.” Some business owners are looking to save as much as they can toward retirement, as quickly as they can. Others are interested in a plan with low costs or the easiest administration. A financial planner or attorney who practices in retirement planning can help you evaluate your priorities and decide which plan is right for you.  Here are your primary options.

SEP IRA

The Simplified Employee Pension Individual Retirement Account, or SEP IRA, is a popular option for smaller companies. With this option, an employer contributes to IRAs established for each individual employee. The employer’s contribution must be the same percentage of salary for all employees, including the employer. For instance, if the employer contributes 5% of their own compensation to their SEP IRA, they must contribute 5% of each participating employee’s compensation to the employee’s IRA. Contributions are made by the employer only, and there is a maximum contribution limit which may change annually.

Pros

• Cost-effective and relatively low-maintenance
• Wide variety of investment options
• Tax credit available for small employer plan start-up costs
• Business owners’ contributions to their own plans, as well as employees’ plans, are tax-deductible
• Annual contributions are not required
• Available to sole proprietors without employees

Cons

• IRA owners cannot borrow against their savings; early withdrawals are available but subject to an additional 10% tax
• Contributions vest immediately, which may reduce employee incentive to stay in their job; they do not have to stay with the company until their contributions vest, as with other plans
• No catch-up contributions are available for older workers

SIMPLE IRA

With a SIMPLE IRA, unlike the SEP IRA, employees can make their own contributions to the plan. Employers must make either a matching contribution of up to 3% of employee compensation, or a nonelective contribution equal to 2% of the employee’s compensation. 

Pros

• Some providers charge employers nothing, or a small fee, to set up and administer the plan
• Easier to set up and administer than a 401(k)
• Employer pre-tax contributions made by the business are tax-deductible to the employer
• As of 2023, there is an option for employers and employees to make post-tax (Roth) contributions if certain requirements are met
• Tax credit for start-up costs may be available to small employers 
• Available to sole proprietors without employees

Cons

• As with SEP IRAs, IRA owners cannot borrow against their savings; early withdrawals are available but subject to an additional 10% tax
• Lower contribution limits than a 401(k)
• You cannot make contributions to a SIMPLE IRA if you have made contributions to another qualified plan in the same year
• As an employer, you cannot maintain a SIMPLE IRA plan if your company had more than 100 employees with over $5,000 in compensation in the previous calendar year

401(k) Plan

A 401(k) is an employer-sponsored retirement plan to which employees can contribute income and employers can make matching contributions. With a traditional 401(k), contributions are made on a pre-tax basis, reducing participants’ taxable income. Distributions (including earnings on contributions) are taxed as income when withdrawn. Employers may also offer a Roth 401(k), to which participants may contribute after-tax dollars; growth on contributions and distributions from the plan are tax-free.

Pros

• Higher contribution limits than IRAs
• Employer contributions deductible up to 25% of aggregate employee compensation for the tax year
• Employers can impose vesting requirements for contributions, which may incentivize valued employees to remain with the company
• Unlike with an IRA, loans may be taken from the plan account
• Employers may be eligible for a tax credit for qualified plan start-up costs
• Available to sole proprietors without employees

Cons

• Significantly more administrative work is involved for employers to comply with IRS requirements; retaining a third-party administrator reduces this work, but increases the cost of administration

Retirement Options for Business Owners Without Employees

If you are the only employee of your business, you can establish a SEP IRA or SIMPLE IRA for yourself. Should you later expand your team, you can make the plan available to your new employees. You can also create a solo 401(k).

A solo 401(k) is available to an owner of a business that does not have any non-owner full-time employees or long-term part-time employees. If you have a solo 401(k) and hire employees, you would no longer qualify for the simplified solo 401(k). In that case, you could either upgrade to a full 401(k) plan so that you could make it available to your employees, or terminate the plan and roll your own 401(k) into an IRA plan.

To learn more about the types of retirement plans for small business owners, contact Estate Planning & Elder Law Services to schedule a consultation.