Retirement Plans for Small Business Owners to Consider

Owning a business can be one of the most fulfilling feelings, especially when you have a financial advisor who is there for you each step of the way.  One of the ways your financial advisor can assist your business is to help you set up a small business retirement plan to benefit your company, your employees, and your retirement plans.

From making decisions about the smallest things like ordering supplies to bigger decisions like expanding into new markets, many responsibilities come along with running a small business.  But, small business owners often get so focused on running their business today they forget to plan for tomorrow.

Good Days Today, How About Tomorrow?

In between the chase of better sales and growing your small business, you might find yourself losing sight of the big picture.  As humans, we often ignore the planning that concerns the longer road ahead: your retirement. While owning a small business brings you the satisfaction of building your own business, it also means the burden is on you to select the retirement plan for your small business that will fit your unique goals.

Now you might be thinking, why exactly am I in need of any retirement plans? I’ll work for as long as I can, or until the very end. Or you might be saying right now, “I will just sell my business when I am ready to retire and live off the proceeds of the sale.”

But the world is full of unknowns and risks. With the COVID-19 pandemic, many business owners were forced to close the businesses they worked so hard for.  Technological changes and competitors can also disrupt your carefully laid business plans.  There is much uncertainty in running a small business, especially over many years. Having a plan outside of selling your business or working until you drop can help you have a more secure retirement plan, and ultimately sleep better at night.

4 Retirement Plans for Small Business Owners to Consider

Answering a few questions upfront can help you determine which small business retirement plan is right for your firm.  The time you spend on setting up the right plan today can pay you dividends for years to come.

First, ask yourself how much time you have for administration.  Some plans are simple to administer and other plans require some time commitment from you as the small business owner or your staff.  Second, consider how much you would like to contribute to your small business retirement plan.  Some plans have much higher contribution limits for both you and your employees.  Third, how many employees do you have on payroll?  Is it just you, a small handful of trusted employees, or do you have many employees on your payroll?  Some plans are better for solo business owners while other plans may be better suited for small businesses with fewer employees.  Fourth, if you do have employees, would they want to contribute to the plan?  For many employees, the opportunity to participate in a retirement plan at work can be a valuable hiring and retention tool for small businesses. Finally, would you like to be able to take tax deductions for running your small business retirement plan?  There are opportunities for small businesses to receive tax credits for setting up new plans.  Also, contributions and plan expenses paid by your company can further reduce your tax burden while allowing you to save for your retirement!

Once you have the answers to these questions, here are four Retirement Plans for Small Business Owners to consider for your small business.

1.      SEP IRA

Pros:

• Easy to set up and administer
• Low administration cost
• Flexible annual contributions – good when cash flow is an issue
• High contribution limits

Cons:

• Employers must contribute equally for all eligible employees
• No loans available

If easy administration is your priority, a SEP-IRA might be right for you. The SEP-IRA gives you the ability to decide when and how much to contribute to your small business retirement plan.  A SEP IRA is similar to a profit-sharing plan because you as the small business owner make the contributions to the plan for yourself and any employees.

If you are familiar with the Traditional IRA, a SEP IRA is very similar but with some higher contribution limits. You can save up to 25% of compensation or a maximum of $58,000 in 2021 to a SEP IRA, with some special adjustments for self-employed individuals.  These contributions are deductible as a business expense  As the employer you decide each year if you want to make contributions to the plan.  You can decide to make contributions in good years and not make contributions in lean years.  A SEP IRA is easy to set up and has very low administration costs.

However, with the ease of administration and low administration cost, any contributions you make must also be made on behalf of your employees as well.  For example, if you contribute 10% to your SEP IRA, you must also contribute 10% to all of your employee’s accounts as well.  You can exclude some employees from the SEP-IRA.  For example, employees who are under 21, earn less than $650 a year, or who haven’t worked for you three out of the past five years can be excluded.

2.      Simple IRA     

Pros:

• Easy to set up and administer
• Low administration cost
• Medium contribution limits
• Employees can make contributions on their own

Cons:

• Employers must contribute to employee accounts each year
• No loans available

If you replied yes to the question about your employees wanting to contribute to a retirement plan, then the SIMPLE IRA plan is for you.  Like a SEP IRA, a SIMPLE IRA is easy to administer but also allows your employees to make contributions.

If your business 100 or fewer employees, a SIMPLE IRA might be appropriate. Employees are permitted to make salary deferral contributions of up to 100% of their pay. The business also contributes to the plan.  Small business owners operating a SIMPLE IRA can choose to either contribute 3% to match employee contributions or an automatic 2% contribution for all employees.  These matching contributions are deductible as a business expense.  Employees can contribute up to $13,500 annually and employees who are over the age of 50 can contribute an additional $3,000 in 2021.

The benefits to this choice include easy setup and low-cost administration.  Employees can contribute to the plan and compare it to a SEP IRA while the employer may have lower levels of contributions to make for employees.  Disadvantages include lower contribution limits, annual commitments to making contributions to employee accounts, and no loans available.

3.      Simple 401(K)

Pros:

• Medium contribution limits
• Employees can make contributions on their own
• Loans and hardship withdrawals are permitted
• Not subject to non-discrimination testing like regular 401(k) plans

Cons:

• Employers must contribute to employee accounts each year
• Must file Form 5500 annually
• Fixed contribution schedule

A Simple 401(k) is very similar to a SIMPLE IRA with one notable difference: employees can take out loans or hardship withdrawals, which adds to the administrative burden for you as the employer.  But the ability to take out loans and hardship withdrawals may make the plan more attractive to you and your employees.

Like a SIMPLE IRA, if your business has 100 or fewer employees, a Simple 401(k) might be appropriate. Employees are permitted to make salary deferral contributions of up to 100% of their pay. Your small business also contributes to the plan.  Small business owners operating a Simple 401(k) can choose to either contribute a 3% to match employee contributions or an automatic 2% contribution for all employees.  These matching contributions are deductible as a business expense.  Employees can contribute up to $13,500 annually and employees who are over the age of 50 can contribute an additional $3,000 in 2021.

The benefits to this choice include moderate levels of cost to set up and administer.  Employees can also contribute to the plan and compared to a SEP IRA the employer, may have lower levels of contributions to make for employees.  Also, unlike a regular 401(k) plan, Simple 401(k)s do not require non-discrimination testing because of the set employer contribution requirements.  Disadvantages include lower contribution limits, annual commitments to making contributions to employee accounts that are not flexible like a regular 401(k), annual 5500 filings, and no loans available.

4.      Solo 401(k)

Pros:

• High contribution levels
• No non-discrimination testing
• Simple administration
• Loans and hardship withdrawals are available
• ROTH 401(k) options

Cons:

• Can only be used with businesses with no employees
• 5500-EZ filing requirement once your plan grows beyond $250,000

This type of retirement plan is good for small businesses without employees.  You can also use this plan if your spouse is the only other employee in your business. As a small business owner, you are both employee and employer allowing you to contribute to a Solo 401(k) as both employee and employer.

You also get higher contributions limits with relatively easy administration.  You can save 100% of your compensation, with some adjustments for self-employed individuals, up to $19,500 in 2021, and if you are age 50 or above you can save an additional $6,500.  In the Solo(k) these contributions can be either pre-tax and reduce your current taxable income, or you can choose to contribute to a Solo Roth 401(k) with after-tax dollars and get tax-free distributions during retirement.  In addition, you can make tax-deductible contributions as the employer for a total contribution amount of $58,000, or $64,500 if you are age 50 or older.  Employer contributions are tax-deductible for your small business.

A Solo 401(k) has minimal expense to set up and is relatively easy to administer. If your Solo 401(k) account balance is less than $250,000 you do not have any annual reporting requirements.  However, when your account grows beyond $250,000, you’ll need to file Form 5500-EZ with the IRS annually.

This plan is a good option for small businesses with no employees who want to have relatively easy administration and high deferral limits.

Conclusion

As a small business owner, you have to balance both running your business today and planning for your retirement.  By choosing the right retirement plan for your goals, you put yourself on this path toward a successful retirement.  However, selecting and running a retirement plan for your small business is undoubtedly a huge responsibility on its own. No one wants to waste a lifetime of work and savings through poor planning or investment choices.  A financial advisor committed to your success both today and tomorrow can help you navigate through the choices and make a choice that is right for both you and your business.

At 3 Financial in Honolulu, we have years of experience helping small business owners navigate their retirement plan choices.  Choosing the right plan is a big task – and you don’t have to go it alone.  Get the right financial help and guidance to pick a plan that fits your small business needs and your personal retirement goals by contacting us today.

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