Hi, it’s your Money Mavens. Can we talk about your business and retirement?
Because that’s the big question over 10 million Americans are facing right now.
“What’s the best way for me to save for retirement as a business owner?”
Self-employed. Entrepreneur. Business owner. All essentially in the same boat…
If you’re self-employed or own your own business, there are several accounts that can be used to save for your retirement while also reaping the tax benefits.
There’s just one problem: not all retirement plan options are right for all business owners.
But you’re not reading this to hear about all the options that are better for others.
You want to know which option may be best for you.
The answer? It depends. Now, before that seems like a throwaway answer, let us explain…
The right retirement plan for you as a business owner depends on several key factors, such as:
- How many employees do you have?
- How much can you afford to save every year?
- How much time and money are you willing to spend on administering a plan?
- How is your business structured? S Corp, C Corp, sole proprietor, etc.
The good news is you likely have more freedom to choose than ever before.
While it may be easier to plan for retirement contributions as an employee, being your own boss has gobs of benefits, including more than one type of retirement plan.
(“Oooh, do tell more!”)
You’re the Profit Boss now, right? So, let’s find a plan that flatters you as well as a little black dress.
Door #1: Regular 401(k)
Consider a regular, garden-variety 401(k) plan if you have more employees than just you and your spouse.
You’ll need to have consistent, solid profits year after year and understand that the set-up costs and administration can be high.
Also, in order for you to save the maximum amount to your plan each year, you may need to make employer contributions for your employees, which isn’t a bad deal, but you need to know these details.
Pros of choosing a regular 401(k) as a business owner:
- You can save up to $61,000 in 2022 (plus $6,500 catch up if you’re over age 50 – for a total of *drumroll, please* $67,500).
- It’s a great recruitment and retention tool because you are doing a lot to help your employees save for retirement.
- Can include a Roth option (non-deductible).
- Regular contributions are tax-deductible.
Cons of choosing a regular 401(k) as a business owner:
- A regular 401(k) can be expensive for you, the business owner. Costs like contributions to your employees’ accounts and the plan expenses can add up.
- As the trustee of the plan, you are the fiduciary who is responsible for ensuring you offer a plan that is fair to all participants. You are responsible for selecting a diverse line-up of investment options.
- NOTE: There are options to delegate your fiduciary responsibility so that you and your team get preset investment options and if you get sued someone else takes the brunt of it. For example, Hendershott Wealth Management is a fiduciary advisor on the retirement plans we manage. We call this limiting the exposure and liability elements of you as a plan administrator.
Door #2: Simplified Employee Pension (SEP)
Consider a SEP if you have a very cyclical business and you want flexibility each year as to whether to contribute or not.
You’ll need to show business profits to contribute at all. You might consider this the ‘commitment-hesitant/cold-feet’ retirement plan. Consider if you have a few employees.
Pros of choosing a SEP retirement plan as a business owner:
- Easy to administer and tends to be more cost-efficient
- Contributions are tax-deductible
- You can contribute up to 25% of net income, up to $61,000 in 2022. You have until your tax filing deadline (plus extensions) to make your contribution.
- You don’t have to commit to contributing each year.
Cons of choosing a SEP retirement plan as a business owner:
- Amount you can contribute is limited by your business profits
- Each employee has to open their own individual accounts
- No catch-up contributions if you’re over age 50
- You must contribute on your employees’ behalf at the same percentage of compensation that you contribute to your own. Example: if you contribute 10% of your compensation to your SEP, you must contribute 10% of their compensation to their SEPs.
- Your tax planner will have to calculate your potential account contribution each year after the calendar year is complete.
Door #3: Solo 401(k)
Most business owners start with a Solo(k) in their first few years in business.
It’s fairly straightforward and not administratively cumbersome while allowing you and your spouse to contribute at the level of a regular 401(k).
It’s also a type of account that will allow you to make contributions without showing profits.
So, if your business is operating at a loss, as long as you are paying yourself a salary, you can still defer income toward financial independence.
A Solo(k) is likely your best option if you have no employees besides you and your spouse.
Pros of choosing a Solo 401(k) retirement plan as a business owner:
- Cheaper, faster, and easier to set up than a regular 401(k) plan.
- Easy to administer.
- You can save up to $61,000 in 2022 (plus $6,500 catch up if you’re over age 50 – for a total of $67,500) through a Solo(k). As a self-employed person, you can contribute as the employee and as the employer.
- Up to $20,500 (plus the $6,500 catch up if over age 50) of which is considered employee deferrals and you can contribute that as long as your income was at least $20,500 ($27,000 if over age 50). So that is the portion not based upon a percentage of your income. These contributions must be made before 12/31.
- Your employer contribution is calculated as up to 25% of your net self-employed income. These contributions can be made up until 4/15 of the following year.
- Contributions are tax-deductible.
- You don’t have to commit to contributing each year.
Cons of choosing a Solo 401(k) retirement plan as a business owner:
- Once your account balance is over $250,000, there are additional regulatory reporting requirements. Most business owners have their accountant file these for them.
- If you decide to hire employees later on, you won’t be able to continue this plan. You’ll need to close it down and may need to wait a year before starting a new regular 401(k) plan.
4 Questions to Help You Decide Which Retirement Plan May Be Best for You as a Business Owner?
Before you can decide which retirement plan is best for you as a business owner, you should ask yourself the following questions:
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- How much money do I want to save each year?
- How much money can I afford to save for retirement each year?
- How many employees do I have now? Do I plan to hire more soon?
- How much time am I willing to carve out for administering a retirement plan? And what type of budget am I comfortable with for administration costs?
If you are self-employed, there are good options available for you and it’s never too late to start saving for retirement!
To your prosperity,
Your HWM Money Mavens
