Which Retirement Accounts are Best for Business Owners?

As a business owner, planning for the future of your company is a necessity, and retirement is a crucial part of that. Taking care of employees is important, but you also want to ensure you make the right decisions about your own retirement to maximize your tax-deferred contributions. 

There are plenty of options to choose from when planning your retirement. But are there certain accounts that are better for business owners? 

Well, yes, there are. 

Here are the best retirement account choices for business owners.

In a snapshot, they are (in no particular order):

  1. Traditional or Roth IRA
  2. Solo 401(k)
  3. SEP IRA
  4. SIMPLE IRA

Let’s take a look at each type of account and view the pros and cons of each.

1. Traditional or Roth IRA

A traditional IRA, or individual retirement account, lets you contribute toward your retirement savings with pre-tax dollars. The amount can grow tax-deferred and will be taxed upon withdrawal during retirement at that current tax rate. As well, capital gains and dividends are not taxed until withdrawals are made.

There are limitations, however, to how much you can contribute during a given year. For the 2021 tax year, you can contribute up to $6,000 if you are under 50. If you are 50 and over, you may have the option of contributing up to $7,000 due to a catch-up contribution provision which allows you to make up more ground in your savings as you approach retirement.

There is no age limit to invest in a traditional IRA. As long as you earn an income, you qualify.

A Roth IRA carries most of the same attributes as a traditional IRA, including contribution limits. The main difference, however, is that you’ve already paid taxes on the money you contribute to a Roth IRA (the contribution amount isn’t deducted on your tax return) and can be withdrawn tax-free (including all of the compounded growth) in retirement. You also won’t be subject to required minimum distributions during your lifetime as with a traditional IRA.

2. Solo 401(k)

A typical 401(k) plan is a retirement account with tax-advantages that employers offer to their employees. Employees can contribute to the plan, and employers may also make matching contributions. For a traditional 401(k), contributions are made tax-free but are taxed upon withdrawal in retirement. 

A Solo 401(k) is one of the best retirement accounts for business owners. It is a 401(k) plan designed specifically for business owners, who have no other employees, and their spouses if they are also employed by the business. If you are a sole proprietor or independent contractor, a solo 401(k) is a great option to save up for retirement. The plan can be used by any small business (corporations, LLCs, and partnerships), but the same limitations apply – the only eligible participants are the business owners and their employed spouses.

These plans allow for both employee and employer contributions up to a combined total of $58,000 (or $64,500 for those aged 50 and over). For 2021, the employee contribution (also known as the elective-deferral contribution) limit is $19,500, plus $6,500 for those who are 50 or older. The employer contribution (also known as profit-sharing) limit is 25% of your compensation (20% for a sole proprietor) or up to the combined employee and employer maximum contribution of $58,000, whichever is less.

3. SEP IRA

SEP IRA is abbreviated from simplified employee pension individual retirement account. Just like a Solo 401(k), a SEP IRA is a retirement account for business owners and those who are self-employed. It provides similar benefits and tax breaks.

Just like a 401(k) or a traditional IRA, the SEP IRA allows for annual contributions which are tax-deductible, grow tax-free, then are taxed upon withdrawal in retirement. They also require minimum distributions beginning at age 72 and distributions made before the age of 59 ½ are normally taxed as income (including a 10% penalty).

Perhaps the main difference between a SEP IRA and a Solo 401(k) is that the SEP IRA only allows for employer contributions. These contributions are limited to $58,000 in 2021 or 25% of your net self-employment income, whichever is less. That 25% SEP IRA contribution limit is also subject to a compensation cap of $290,000 in 2021. 

Other differences between the 401(k)s and traditional or Roth IRAs include no catch-up contributions for those 50 and older and required proportional contributions for eligible employees if you contribute yourself.

Also important to note, you may be able to contribute to a SEP IRA and a traditional or Roth IRA in the same year to increase your annual savings. Check with a financial or tax professional to see if you’d qualify. 

4. SIMPLE IRA

A SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees, is a retirement savings plan typically used by businesses with less than 100 employees. Its main benefit is to allow for business owners to save for retirement, while also contributing to the employee’s retirement savings. It is especially useful for startups who need a simple way to provide retirement benefits to employees.

A SIMPLE IRA allows both employers and employees to invest in a traditional IRA that the business sets up. It is similar to a traditional 401(k) that is common in larger companies. However, there are some key differences.

First, your employees are free to choose from a wide range of investment options from your plan’s provider to include in their SIMPLE IRA. They can also choose the amount they contribute out of each paycheck, up to the annual limit of $13,500 in 2021. Employees age 50 and older can make up to a $3,000 catch-up contribution above the annual limit. These contributions are tax-deferred, but taxable upon withdrawal in retirement. 

It’s important to note that, as a business owner, you are required to contribute to employees participating in your SIMPLE IRA plan. You must either match each employee’s salary reduction contribution up to 3% of their compensation or make nonelective contributions of 2% on up to $290,000 of their compensation in 2021. For nonelective contributions, you are required to contribute for all eligible employees, even if they made no salary reduction contributions throughout the year. 

We get it, when it comes to choosing the right retirement plans for business owners, there are many options to choose from. Not sure which retirement plan is right for you? Talking to a fee-only fiduciary financial advisor can help you better understand the different retirement strategies available to you and which one is the best choice for you.

Contact us today to get personalized help on choosing the right plan for your retirement.