A Business Owner’s Guide to Retirement Plans
How can a financial advisor help a small business? As financial advisors in Gilbert, AZ, the team at Watts Gwilliam and Company work with many high-income-earning business owners, both locally and nationwide. In our experience, there are a few specific places where business owners tend to take a wrong turn with their financial planning.
One of these important places is retirement.
In fact, according to reports, 34 percent of business owners don’t have a retirement savings plan at all. Common reasons we hear are:
- They don’t feel like they have enough income to save.
- They’ve used all their previous savings to invest in their business.
- Their “retirement plan” consists of selling their business and living off the proceeds.
Even if you don’t plan on ever fully retiring, having a retirement plan in place gives you options. Having a safety net, of sorts, to fall back on if you change your mind down the road or are forced to retire early can help prevent you from having to rely on government aid and/or part-time work if things don’t go as planned. Being prepared for the unexpected can also provide peace of mind.
Another reason we see business owners put off their retirement planning is because they simply don’t know where to start, becoming overwhelmed very quickly with all the options and information available, especially in the age of the Internet.
There are many perks to owning your own business – and seemingly just as many retirement plans to choose from as a self-employed individual. This is where we see many business owners get stuck, so we want to break down 5 of the most popular retirement plans for business owners, along with their pros and cons.
If you have a question that is not addressed here or would like to discuss your specific situation in more detail, let’s talk. The Watts Gwilliam team is here to help you figure out how to optimize your plan benefits to save for a happy and fulfilling retirement.
Own your business? Schedule a no-obligation conversation with the team at Watts Gwilliam and Company to see how we can help.
SEP IRA
A SEP IRA can be especially beneficial for sole proprietors, partnerships and corporations with zero to 20 employees. These plans are pretty easy to set up and allow you to contribute up to $58,000 a year or 25 percent of your salary, whichever is less.
But there are two caveats to keep in mind:
- A SEP IRA is solely funded by employer contributions (meaning your employees can’t add in their own money).
- You’re required to contribute the same percentage to all eligible employees (meaning if you save 20 percent of your salary in a SEP IRA, you’re required to put 20 percent of your employees’ salaries in their accounts, too).
Pros
- Easy to set up
- No operating or startup costs
- Higher contribution limit than standard IRAs
- Employer contributions are vested immediately
- Employer contributions are tax-deductible
Cons
- Employer contribution must be the same percentage for all employees
- No elective salary deferrals or catch-up contributions allowed
SIMPLE IRA
A SIMPLE (Savings Incentive Match Plan for Employees) IRA can be beneficial for small business owners with up to 100 employees. These plans are typically used as a start-up retirement savings plan for business owners who aren’t quite ready to offer a full-blown 401(k).
Employees can contribute up to $13,500 a year to their SIMPLE IRA for 2021 (or $16,500 if you’re at least age 50). As the employer, you’re required to do either a 3 percent matching contribution or a 2 percent non-elective contribution, whichever you prefer.
Any employee can participate in a SIMPLE IRA as long as they’ve earned at least $5,000 within the past two years and are on track to earn at least $5,000 in the current year.
Pros
- Gives employees a way to save for retirement
- Easier to set up and less expensive than a Traditional 401(k)
- Can customize contribution allocations for each employee
- Employer contributions are tax-deductible
Cons
- The contribution limit is lower than a Traditional 401(k)
- Employer matching program is required
- There is no Roth option
- There are steep withdrawal penalties (employees will pay a 25 percent fee if they do an early withdrawal or rollover within two years of opening the account)
Traditional or Roth IRA
Traditional and Roth IRAs are technically for anyone – not just small business owners. IRAs tend to be the easiest accounts to open on this list because they don’t require any business documentation. All you have to do is pick a brokerage firm and open an IRA just as you would a regular checking or savings account.
For both a Traditional and a Roth IRA, you can contribute up to $6,000 a year for 2021 (or $7,000 if you’re at least age 50). The only difference between these two accounts is when your money is taxed.
With a Traditional IRA, you fund the account with pre-tax dollars and pay taxes in retirement. With a Roth IRA, you fund the account with after-tax dollars and enjoy tax-free withdrawals in retirement.
Because Roth IRAs offer a big tax break for American workers, the IRS places income limitations on who qualifies for one. For 2021, you can contribute to a Roth IRA if you make less than $208,000 as a married person filing jointly or $140,000 as a single filer. If your income is over these limits, you can still technically contribute through a Backdoor Roth IRA; it just requires a few extra steps. For more information on this, let’s talk!
Pros
- No plan documents required
- Any American worker can open one
- As easy to set up as a regular checking or savings account
- You can choose if you want a tax break now (Traditional IRA) or a tax break in retirement (Roth IRA)
Cons
- Can only contribute up to $6,000 a year or $7,000 if you’re at least age 50
- There are income restrictions for Roth IRAs
- You can’t open one up for your employees (they have to do it themselves)
- You can’t make employer contributions to any employee IRA
Self-Employed 401(k)
Self-employed 401(k)s, also known as solo 401(k)s, are beneficial for business owners with no employees (excluding a spouse).
Self-employed 401(k)s tend to especially benefit high-income-earning business owners who are structured as sole proprietors, S Corporations or C Corporations. These plans are unique because you can make contributions as both the employer and as an employee of your company.
On the employee side, you can contribute up to $19,500 or up to $26,000 if you’re at least age 50 – the same as with a Traditional 401(k). On the employer side, you can make a non-elective profit share contribution of up to 25 percent of your W2 salary or $58,000, whichever is less.
Pros
- There’s no vesting schedule
- Supports salary deferrals and profit-sharing contributions
- There are no Form 5500 filings until plan assets exceed $250,000
- Has a higher contribution limit than a regular 401(k)
- Can cover your spouse if he or she earns income from your business (effectively doubling the amount you can save as a family)
- Can choose between a Traditional or Roth solo 401(k)
- Opens the door to potential Back Door Roth contributions
Cons
- Requires a lot of paperwork to set up
- Typically can’t open online (you have to call or mail in your application)
401(k)
Once your company has at least 20 employees, you may want to consider designing an employer-sponsored 401(k) plan. This can help you attract talented workers, retain valuable employees, enjoy specialized tax benefits and remain competitive in your industry.
As the employer, you have the flexibility to design the plan however you want. You can match employee contributions, allow participants to borrow from their 401(k)s, create your own vesting schedule and even choose to offer multiple types of 401(k)s, such as a Traditional, Safe Harbor, or Roth 401(k).
For 2021, employees can contribute up to $19,500 to their 401(k) or $26,000 if they’re at least age 50.
Pros
- Tax-deferred growth and pre-tax contributions for employees
- Employer contributions are tax-deductible
- Includes a broad range of investment options
- Contributions are made via salary deferrals
- Opens the door to potential Back Door Roth contributions
Cons
- Administrative fees can get expensive
- Must file IRS Form 5500
- Typically requires an annual nondiscrimination test to ensure your plan doesn’t favor highly compensated employees
How a Financial Advisor Can Help
How can a financial advisor help a small business? A lot of business owners fall behind on choosing a retirement plan because they’re either overwhelmed by the number of plan options available to them, or they think living off of business proceeds will be enough to afford them a comfortable retirement.
If this is you, schedule a no-obligation conversation with the Watts Gwilliam team. Our financial advisors in Gilbert, AZ can help align your goals to your financial plan, review your business structure and choose a retirement plan option that offers you a safety net.
At Watts Gwilliam and Company, our financial advisors can also help you:
- Design a retirement plan that benefits you and your employees
- Bring your personal finances in alignment with your business finances
- Mitigate personal and business taxes
- Streamline cashflow to grow your business
- Create a solid exit strategy and succession plan for your business
For more information, the Watts Gwilliam team put together this guide: Financial Planning for Business Owners.
