Owning your own business isn’t always easy, and that’s true when it comes to everyday decision-making as well as planning for the long-term. You’re basically in charge of everything that happens (or doesn’t happen), as well as the consequences — both good and bad. You also have a lot more work to do when it comes to planning for taxes and for your eventual departure from the world of work.
But retirement planning is far from impossible, especially since there are multiple retirement accounts that can help you invest more than you ever could with a traditional 401(k) plan.
If you own your own business, saving for retirement with one of these plans can help you reach your goals and reduce your taxable income. Still, you should do your research to find out which type of retirement plan suits your needs best.
A Simplified Employee Pension (SEP) can be opened by a business owner or someone who is self-employed. This type of account lets you contribute to your employee’s retirement accounts if you have employees, but you can also use it to grow your own retirement savings.
While the SEP IRA can be a good choice for small business owners with no employees or a spouse as their only employee, you’ll want to be picky about this plan if you have multiple employees. That’s because the IRS sets terms for who is considered an eligible employee at your business, and because you are required to contribute an equal percentage of their income to their accounts as you do their own. In other words, if you contribute 10% of your income to your SEP IRA, you must do the same for all eligible employees.
According to the IRS, an eligible employee is someone who meets all of the following requirements:
- They are 21 or older
- They have worked for you for at least 3 of the last 5 years
- They earned at least $650 in compensation from your business for 2021
Fortunately, contribution limits for the SEP IRA are high. If you’re self-employed, you can contribute up to 25% of your net earnings from self-employment with a maximum of $58,000 in 2021. Interestingly, SEP IRA accounts do not allow “catch-up” contributions for older workers like some other retirement plans do.
Another option to consider is the Solo 401(k) plan, which is sometimes called a one-participant 401(k). This type of plan is geared to self-employed individuals who don’t have any employees, although it also works for a self-employed person and their spouse.
The Solo 401(k) lets you contribute as an employer and as an employee. On the employee end, you can defer up to 100% of your compensation up to an annual limit of $19,500 (or $26,000 total if you’re ages 50 or older). On the employer end, you can also contribute up to 25% of compensation.
The contribution cap for the Solo 401(k) is $58,000 in 2021 as well, so this account can be a useful tool when it comes to saving for retirement and reducing your income tax bill.
The SIMPLE IRA lets employers and employees invest for retirement, and this plan is known for its lack of start-up and operating costs. This account is also typically available to small businesses with 100 or fewer employees.
Generally speaking, the employer is required to contribute one of the following to their employee’s plans: a matching contribution of up to 3% of their compensation, or a 2% nonelective contribution for each employee. Employees are also always 100% vested in their SIMPLE IRA plan.
In 2021, the maximum contribution to a SIMPLE IRA is $13,500, although an additional catchup contribution of up to $3,000 is allowed for individuals ages 50 or older.
Traditional or Roth IRA
Another type of retirement plan to consider in addition to, or instead of, other options is the traditional or Roth IRA. Both the traditional and Roth IRA have the same combined contribution limit of $6,000 in 2021, but you can contribute an extra $1,000 in catch-up contributions per year if you’re ages 50 or older.
Traditional IRA contributions can be tax-deductible if you meet eligibility requirements, such as not having a retirement plan at work and having an income that does not exceed limits set by the IRS. Whether you can deduct contributions or not, your traditional IRA funds get to grow tax-free, and you’ll only pay income taxes when you begin taking distributions in retirement age.
With the Roth IRA, on the other hand, you make contributions with after-tax dollars. However, your money grows tax-free and you can take withdrawals in retirement without paying income taxes.
With that being said, the Roth IRA has income caps that limit who can contribute. If you’re married and you file taxes jointly with your spouse, for example, your modified adjusted gross income (MAGI) must be below $208,000 to contribute to a Roth IRA, and your MAGI must be below $198,000 if you want to contribute the full amount.
Plan an Exit Strategy for Your Business
While the retirement plans I outline above can be advantageous for entrepreneurs who want to begin investing, the value of your business should also be factored in. After all, business owners who have remained in operation for decades may find their business is their largest asset, or at least an asset that can help cover the long-term costs of retirement.
With that in mind, there is a lot to consider when planning an exit strategy for your business, including who you might sell it to and when. You also need a solid valuation of your business that you can plan around, as well as the know-how to make the sale as tax-efficient as it possibly can be.
At the end of the day, investing for retirement is a smart move, even if you plan to sell your business to help fund your golden years. Doing both can also help you diversify your strategy so you won’t be left holding the bag if your business loses value or the stock market tanks.
Whatever you do, start planning for your future retirement now — even if you need professional help to know which financial moves to make. If you fail to plan for retirement as a small business owner, you could live to regret it.