Sorting out Retirement Solutions for the Small Business Owner
Five retirement plans you may want to consider
Many times people come into my office looking for advice on how to appropriately plan their financial future. Asset location is often just as important as asset allocation. While asset allocation looks to spread your assets among many different assets classes, asset location helps you spread your assets among taxable, tax-deferred, and potentially tax-free accounts. Many who are employed by a corporation have retirement planning options at work, but what about the business owner? How do you choose the best location for your assets and that of your employees?
So you own your own business, who’s planning your retirement?
If you own your own company and want to have a retirement program for yourself and possibly your employees, here are five plans you may want to examine.
1. The SEP IRA.
A Simplified Employee Pension IRA plan allows you to make contributions toward your retirement and your employees’ retirements. You can also enjoy the benefits of a SEP and still add to other kinds of retirement accounts at your business simultaneously. The limitations are generous also. For example, A SEP IRA allows business owners annual tax-deductible contributions equal to 25% of your compensation if you set up your business as a corporation. As a sole proprietor you are allowed to contribute 20% of your self-employment income.
2. The solo 401(k).
Many ignore 401(k)s once they set up their own business because they are unaware that they are a possibility. You are allowed to set up 401(k) when you are self-employed. You can include yourself, your spouse (if he or she is an employee), and other employees.
Solo 401(k)s also have a profit sharing twist. They may be funded by the employee through deferred compensation and the business as a percentage of profit. The annual contribution limits are $16,500 for those under age 50. If you are over age 50, you can put in additional $5,500. Additionally, solo 401(k) plans allow you to make tax-deductible profit-sharing contributions equal to 25% of your compensation (corporate entity) or 20% of self-employment income (sole proprietor). You also have the potential to set up a solo Roth 401(k) for potentially tax free growth. However, there is more paperwork and cost to set up as these plans do require a third-party administrator.
3. The SIMPLE IRA.
SIMPLE plans as they imply are very easy to create. They also have very low administrative costs and no annual IRS reporting requirements. Both of these advantages make these plans attractive to business owners who like to keep it simple! You simply set up a traditional IRA for each eligible employee. The employee can then contribute to the IRA on a tax-deferred basis via payroll deductions. You then choose to either match the contributions of plan participants or you can contribute a fixed percentage of all eligible employees’ pay. The employees fully own all the money put into these plans.
4. Profit-sharing plans.
Do you want to compete with larger companies for talented employees? Profit sharing contributions are usually deductible at both the federal and state levels. They also share generous contribution limits (equivalent to a SEP). Annual tax-deductible contributions may be made according to the 25%/20% rule depending on your business entity. Contributions are not required. If your business cannot afford to make contributions during a down year, you can choose to skip payments. Any assets placed within the plan grow tax-deferred.
5. New comparability plans.
These plans are essentially a profit-sharing plan set up to reward senior or key employees more than others. The most appropriate use of this type of plan is when you have a small business with multiple owners having similar incomes but varying ages. Keep in mind: These plans must be tested to meet Internal Revenue Code nondiscrimination requirements. It’s most attractive selling point is the different levels of compensation allowed to be contributed to different groups within your business.
Which plan is right for you?
If you are thinking about putting a plan into place or switching to a retirement program more easily administered than the one you have now, don’t go it alone. Talk to your CPA, a financial advisor, or professional with expertise in the retirement plan marketplace. Which one should you choose – and what is the next step? Take your first step today by seeking to find a professional who can help you review your options and find the most appropriate solution that fits your company’s needs.