Retirement Plans for Small Business Owners

Retirement. Just one word can elicit everything from excitement for those bucket-list vacations to the stress of planning for those golden years now while you’re working and able. Perhaps you’re more worried now about your child’s education, or paying for that dream condo in Los Angeles, but the truth is that nowadays more people are living longer, and fewer people are saving for retirement.

Did you know . . .?

• The average retirement age is 63.
• The average length of retirement is 18 years.
• The average savings of a 50-year-old is $42,797.
• Out of 100 people who start working at the age of 25, by the age of 65, 63% are dependent on Social Security, family and friends, or charity.

Click here for more information.

How can a retirement plan benefit me and my business?

If you’re a small business owner, you’re likely not only figuring out how to save for your own retirement, but how to provide benefits to your staff, too. And rightfully so! Having an employer retirement plan has been shown to help boost employee morale. Employees view retirement plans as an investment in their future by the company, so it helps attract talent and reduce employee turnover.
Click here for more information on benefits for your business.

And if you’re an employee, it’s never too soon (or too late!) to think about retirement. A little each year can go a long way, and allowances are even provided by the IRS to help you catch up if you’re older than 50.

Keep in mind:

• Contributions can be made pre-tax, thereby reducing your taxable income. In this case, the funds in the plan grow tax-deferred.
• Certain plans are eligible for Roth contributions which are contributed on an after-tax basis. In this case, earnings and qualified withdrawals are generally tax-free.
• Compound interest, or essentially earning interest on interest, is an excellent tool in your favor.

What are the four main types of retirement plans?

• Savings Incentive Match Plan for Employees of Small Employers (SIMPLE IRA)
• Simplified Employee Pension Plan (SEP IRA)
• One-Participant (Solo) 401(k)
• 401(k)

The first three are typically for small businesses that have fewer than 100 employees. And although the 401(k) has historically been associated with larger businesses, it may still be a viable option.

Let’s go to the nuts and bolts of the plans:

SIMPLE IRA

This option is available only for businesses with fewer than 100 employees. An employee must have earned $5,000 or more during the preceding calendar year.
More information is available here and here on the SIMPLE IRA.

Benefits

• Low cost and easy to set up
• Employees can contribute pre-tax, thereby decreasing their tax liabilities
• The employee is 100% vested meaning they have immediate access to the employer’s contributions

Rules & Limitations

• The employer cannot have any other retirement plan set up through the business
• The employer contributes on a pre-tax basis only
• The employer is required to provide a match for participating employees with the following options:
  • Matching 100% of employee contributions, generally up to 3% of the employee’s salary (see here for more information), or
  • Contributing a fixed 2% percent of each eligible employee’s salary, regardless of whether or not the employee contributes
• Maximum annual contribution: 100% of salary up to $12,500 + $5,000 catch-up (as of 2018) for participants ages 50 and over

SEP IRA

More information on the SEP IRA is available here.

Benefits

• Low cost and easy to set up
• You don’t have to contribute every year
• The employee is 100% vested meaning they have immediate access to the employer’s contributions

Rules & Limitations

• The employee must have worked for the employer 3 of the last 5 years and earned $600 during the year from the employer
• Only the employer is allowed to make contributions
• The employer contributes on a pre-tax basis only
• The employer is required to contribute the same percentage of salary for all eligible employees. So if as an employer you contribute 20% to yourself, you must contribute 20% to all eligible employees
• Maximum annual contribution: 25% of the employee’s compensation or $55,000, whichever is less (as of 2018)

See here and here for more information on rules and limitations

One-participant 401(k)

This option is only available for a business owner with no full-time employees other than the business owner(s) and their spouse(s).
More information on the one-participant 401(k) is available here.

Benefits

• Low cost
• The spouse can contribute if he/she earns income from the business
• The business owner can contribute as an employer and an employee (see rules below)
• Contributions can be either pre-tax, after-tax, or Roth depending on the plan documents
• Loans and hardship withdrawals may be available

Rules & Limitations

• This option has the same rules and requirements as any other 401(k) plan
• Maximum annual contribution: no more than $55,000 not including catch-up contributions, or $61,000 with catch-up contributions (as of 2018)
  • When contributing as an employee, annual contributions may be up to 100% of compensation or $18,500 + $6,000 catch-up for participants ages 50 and over, whichever is less (as of 2018)
  • When contributing as an employer, you can contribute up to 25% of compensation or your net self-employment income

401(k)

More information on the 401(k) is available here and here

Benefits

• Loans and hardship withdrawals may be available
• Contributions can be either pre-tax, after-tax, or Roth depending on the plan documents
• The employer can match the employee’s contributions

Rules & Limitations

• With more complex compliance requirements, this plan has a higher cost than the other options
• Employer contributions may be subject to a vesting schedule where the employee may have increasing access to the matching over a set period of time or full access after a set period of time
• Maximum annual contribution: $18,500 with $6,000 catch-up for participants ages 50 and over (as of 2018)
• Total (employee + employer) annual contribution is either 100% of participant’s compensation or $55,000 ($61,000 including catch-up contributions), whichever is less (as of 2018)

See here for more information on rules and limitations

Retirement doesn’t have to be a cause of stress. Speak with a financial planner if you’re unsure about what’s best for you, and start thinking more about that bucket list!