Learn how to plan for retirement as a small business and decide which is the right choice, so you can leave yourself and your business in strong financial shape.
Whether you work alone, with business partners, or trusted employees, a retirement plan can help you take care of yourself and your team. A retirement plan can also offer tax breaks, attract employees, and help build personal wealth.
How to Decide Which Plan to Pick
As a small business owner, you can choose between three types of retirement plans:
- Simplified Employee Pension Plan (SEP IRA)
- Savings Incentive Match Plan for Employees (SIMPLE IRA)
- Self-Employed 401(k) (SBO 401(k)) plan
All three plans have their own benefits. The plan that’s best suited for your business will depend on:
- How many employees you have
- If you currently work alone, and whether you plan to hire in the future
- Who will contribute to the plan (you, the employees, or both)
- How much you want to contribute
- How much time and money you can spend on setting up and maintaining the plan
If you already have employees, the Self-Employed 401(k) plan is not an option for your business as the plan does not include “common law” employees. The same applies if you have any future hiring plans.
Let’s take a look at all three plans in greater detail.
This type of retirement plan is the only employer-sponsored plan of the three. You can choose this plan if you are:
- Small business with employees
- Sole proprietor
- S corporation
The 2020 contribution limit for this plan is as follows:
- Up to 25% of employees’ salary or $57,000 (whichever is less)
This limit is flexible, which means that you can change the contribution from year to year, depending on the financial situation of your business. This is a great opportunity for businesses that go through years of fluctuating income, or for newly established companies. However, the percentage you choose to contribute to the plan cannot be different from what you contribute to your own retirement plan as a business owner.
This type of retirement plan is free to set up and maintain. There is also no need for filing a Form 5500. For each tax year, you have until April 15th of the following year to make the contribution. All SEP IRA contributions are tax-deductible.
With the SIMPLE IRA, you as a small business owner can set up retirement plans both for your employees and yourself. The rules of who can open a SIMPLE IRA are a bit different than a SEP IRA. The following are eligible to open a SIMPLE IRA:
- Companies with less than 100 employees
- Sole proprietor
- S corporation
The contribution limits are quite different compared to the SEP IRA. You can choose between:
- Option 1: You match up to 3% of your employees’ contribution. The 2020 contribution limit for employees is $13,500.
- Option 2: A 2% contribution of your employees’ salary regardless of whether they contribute or not. The maximum contribution for 2020 is $5,700.
The only difference between the options is whether you, as a business owner, will be required to contribute to the plan. If you go with option 1, you can lower the matching contribution percentage to 1%, but that’s only allowable for 2 out of 5 consecutive years.
In terms of cost and time management, SIMPLE IRAs have a plan fee as well as a participant fee. They don’t require you to file a Form 5500, but you will have to submit annual employee notifications. As a business owner, you can deduct your contributions to a SIMPLE IRA plan.
As stated earlier, this option is only available for small businesses with no “common law” employees. However, if you have business partners who have shares in the company, all of you can be covered by the plan. Spouses can be included in this plan as well.
With a self-employed 401(k) plan, you and your business partner can contribute to the plan both as employees and employers. The contribution limits are the most generous of all plans:
- As an employee, you can make a salary-deferred contribution of up to $19,500 for 2020. If you are over 50, that limit is $26,000.
- The business can contribute up to 25% of your annual salary or $57,000 (whichever is lower). If you are over 50, that limit is $63,500.
If you and your business partner don’t have any plans to hire in the future, this is the best choice for your business. SBO 401(k) is simple to set up and has no maintenance cost. You will be required to file a Form 5500 annually after the plan’s total contribution exceeds $250,000.
Both types of contributions to Self-Employed 401(k) are tax-deductible. If your business is not incorporated, you can deduct contributions for yourself from your personal income. If your business is incorporated, the contributions are considered a business expense.
Next Steps in Retirement Planning
Now that you’re familiar with your options, it’s time to start planning. Take some time to consider a few factors:
- Are you planning on hiring in the future?
- How important is it for you to contribute to your employees’ retirement?
- How much do you, as a business owner, wish to save in retirement?
Answering these questions will help you decide which plan suits your business now, and in the future.
Check out these tips for small businesses hiring new employees.
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