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Retirement Plans for Small Business Owners

How early is too early to start saving up for retirement? The answer is it's NEVER too early... In fact sooner, the better. Small business owners may enjoy freedom and often benefit from more flexibility in their day to day, but many do not have access to the retirement plans and contributions that many full-time employees receive. Let's look at some different strategies for your retirement plans...

What is a SEP IRA?

First, consider setting up a SEP IRA, which stands for a simplified employee pension plan. These plans allow you to save wayyy more money than traditional IRAs. They also allow you to save based on your earnings and they're a simple investment that can be managed without a third party.

Your earnings determine how much money you can put into your SEP. Whereas a traditional IRA allows you to contribute only $6,500 if you are under the age of 50, a SEP allows you to contribute up to $66,000 or 25% of your earnings, whichever is less.

Something to note: Only the employer makes a contribution.  So, if  you're a one-person operation, such as a freelancer, this is a no-brainer. But let's say you have 10 employees, your contribution rate MUST be the same for all of them, and you must be the only contributor to the account; your employees cannot contribute.

What is a solo 401(k)?

You've probably heard of a 401K before...The solo 401(k), also known as a one-participant 401(k), allows you to contribute to your retirement account as an employer as well as an employee. For 2023, you can set aside a certain percentage of your salary with each paycheck up to $22,500 (plus $7500 if you are 50 or older.) However, your employer can also contribute extra money to your 401(k) up to a maximum of $66,000.

You must calculate how much you can contribute as a single, self-employed individual, but you will typically benefit far more than you would a SEP IRA, saving much more money and significantly reducing your tax liability.

The takeaway here is a solo 401(k) is similar to the retirement plans offered by many businesses, except it is only for one person. For sole proprietors and independent contractors, this is an excellent option..

What is a SIMPLE IRA?

A SIMPLE IRA (which stands for Savings Incentive Match Plan for Employees) is a retirement plan that allows both the business owner and the employee to contribute to their retirement savings. This plan is best for businesses with 100 or fewer employees. If your business is a sole proprietorship, you are both the employer and the employee, so SIMPLE IRAs apply to you as well. In this case, all your annual self-employment net earnings are valid for investment in your SIMPLE IRA.

The maximum SIMPLE IRA employee contribution limit is $15,500 in 2023 ($19,000 if you're 50 or older).

The employers can either:

  • Match their employees' contributions dollar-for-dollar up to a maximum of 3% of each employee's salary without any limit.

  • Make a contribution of 2% of each employee's salary (using only the first of $330,000 of salary in 2023) regardless of whether the employee makes contributions or not.

What is a Roth IRA?

A Roth IRA is a retirement plan in which investments grow tax-free and withdrawals are also tax-free during retirement. When money is invested in the account, you pay taxes however your contributions are not tax-deductible.

Setting up a Roth IRA is possible, but it is far more difficult than simply providing the other types of retirement accounts listed here. Instead, the role of Roth IRAs in retirement savings for business owners should be to open these accounts completely outside of your businesses' books and treat them exactly like a personal retirement plan.

Tips for Business Owners

Hire a professional...

Experienced professionals can provide advice on your specific situation and goals, as well as develop a strategy for you based on a variety of plans.

Diversify your investments...

In other words, don't put all your eggs in one basket. If you decide to set up SEP or SIMPLE IRAs for yourself and your team, don't be afraid to set up your own personal traditional or Roth IRA as well.

Choose retirement plans catered to small businesses...

Some retirement plan providers are targeting small business owners with their plans. These plans should make up at least a portion of your retirement savings strategy because they may offer benefits to small business owners that other retirement accounts do not. Retirement savings for business owners can mean looking at opportunities that are intended not just for everyone, but for people like you, whose business ownership presents unique saving challenges.

The Bottom Line

The truth is that retirement savings isn't a one size fits all. Everyone is on a different timeline and have different lifestyles therefore it's not going to be completely straightforward.

Retirement is a personal decision. There are other factors that business owners might have to consider like the possibility of working another job in their later years, travel, time with family, health concerns, and so on. However, with careful planning and making smart moves, you're only doing yourself a favor by choosing to start saving now.

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