small business retirement plans

Small Business Retirement Plans – What You’re Missing

As an owner of a small business, your focus is to ensure it’s long-term success. Often that’s to the detriment of your retirement savings.  Lucky for you the options and flexibility of small business retirement plans are a major bonus of being an owner. You just need to take advantage of them.

Only 50% of small businesses survive past five years according to the SBA

Focusing all your energy and money on growth makes sense. You can’t save for retirement if your business isn’t successful. Feeling comfortable enough to save for retirement seems to be the rub for business owners.  In reality business owners never do and never should feel “comfortable,” but saving for retirement must be part of your business plan.

What is a small business?

The Small Business Administration defines a small business as one with less than 500 employees. Our expertise lies in companies with 1 to 25 employees.

There is a plan for every business. I’m going to focus on the more common of the two types, defined contribution plans. A defined contribution plan does not guarantee a particular benefit in retirement. In these plans, the employee must contribute to their account. Most times the employer will also contribute a matching amount.

The other type, defined benefit plans, also called pension plans, provides a guaranteed benefit at the retirement of the participant. Contributions are made by the employer. 

Defined contribution plan options

Simplified Employee Pension (SEP-IRA)

That’s not a typo. The “P” in SEP stands for a pension. Yes, the SEP IRA is a mix between a pension and an IRA. It’s like a pension because the employer makes all of the contributions.

Reasons to have a SEP

  • Affordable, easy to set up and maintain, the SEP IRA is ideal for the self-employed and those with less than three employees, depending on how much the owner wants to save.
  • Contributions are tax-deductible as a business expense.
  • The contribution cannot exceed the lesser of 25% of compensation or $56,000 (2019).
  • You can skip the contributions. If your business has a down year, you aren’t required to make contributions.
  • Employees can treat the SEP-like a traditional IRA and make contributions on their own up to the annual limits of $6,000(2018), $7,000 if age 50+. However, they may not be able to deduct the contributions because of participation in the SEP and income limits.

Reasons to think twice

  • I mentioned above that a SEP IRA is right for the self-employed and businesses with less than three employees. That’s because you must create a SEP IRA for all eligible employees.
  • The contribution rate for all employees must be the same. For example, if you are the owner and want to contribute 20% of your income to a SEP IRA, you also have to contribute 20% of each eligible employee’s income to their SEP-IRAs.
  • There is no SEP Roth IRA.

The Savings Incentive Match Plan for Employees (SIMPLE) IRA

As long as you have under 100 employees, you can use the SIMPLE IRA. This is our preferred plan for small businesses that have more than three eligible participants that aren’t all family members.

Reasons to have a SIMPLE IRA

  • Like the SEP IRA, the SIMPLE IRA is easy and affordable to set up and maintain.
  • Contributions: Employees can defer up up $13,000 (2019) to a SIMPLE IRA, and those 50+ can contribute an additional $3,000. The amount they defer reduces their taxable income – just like a corporate 401(k) plan.
  • Employer matching options:
  • The employer is required to match each employee’s contributions on a dollar-for-dollar basis up to 3% of the employee’s compensation. OR
  • The employer has the option to make nonelective contributions. Instead of matching contributions, an employer may make nonelective contributions of 2% of each eligible employee’s compensation. The employer must make the nonelective contributions whether or not the employee chooses to make contributions.
  • An employer may decide to match an amount less than 3%, but it must be at least 1% and for no more than two years out of the 5-year period that ends with (and includes) the year for which the election is effective.
  • Contributions are tax-deductible as a business expense.
  • The highest possible contribution allowed is $26,000 (2019), $32,000 if 50 or older.

Reasons to think twice

  • If you have two jobs, participate in a 401(k) and have a business on the side, contributions to the SIMPLE IRA count towards the $19,000 401(k) limit, $25,000 for those 50 and older.
  • Contributions are mandatory, although with a SIMPLE IRA they can be reduced temporarily.
  • There is no SIMPLE Roth IRA.

One Participant 401(k), also called Solo 401(k)

The Solo 401(k) is perfect for a business owner with no employees unless that employee is a spouse. Then both can have Solo 401(k)s. This is our go-to plan for sole proprietorships and partnerships (and spouses if they’re employees) that have the ability/desire to save more than what is allowed with a SIMPLE IRA or SEP IRA.

Reasons to have a Solo 401(k)

  • Contributions: Employee elective deferrals of 100% of compensation up to the $19,000 (2019) or $25,000 (2019) age 50+.
  • Employer nonelective contributions up to 25% of compensation.
  • The highest possible contribution allowed is $56,000 (2019), $62,000 if 50 or older.
  • You aren’t required to contribute to a Solo 401(k) every year. If you have a bad year, you can reduce your contribution.
  • The matching contribution is deductible as a business expense.
  • The Solo 401(k) has falsely gotten a rap for being more expensive than the SEP or SIMPLE IRA plans. It’s not. If you think you’re paying high administration fees, you better shop around.
  • There IS a Solo Roth 401(k) available. Contributions are after-tax, but employer matching is still before-tax, so a Solo 401(k) needs to be opened to receive those deposits.

Reasons to think twice

  • A Solo 401(k) requires slightly more paperwork to set up as opposed to other plans, but it’s not cumbersome.
  • Once there is at least $250,000 in your account, you’ll have to report your benefits with form 5500 annually. Don’t let administrators fool you. It’s not that difficult. It’s a two-page form. Plus, if you wanted to avoid the paperwork, you could roll some of the Solo 401(k) over to a traditional/rollover IRA without any problem to get under the $250K.

Please note the one item all the plans have in common is that each requires computation of self-employment tax to determine the allowable contribution amount. It’s not difficult or time-consuming, but I’ve thrown a lot of info your way and have not included those equations.

It may sound daunting and confusing, but don’t be intimidated. You need to start the process to begin saving for your retirement.

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