Experts estimate that Americans will need 70 to 90 percent of their pre-retirement income to maintain their current standard of living when they stop working, according to the IRS. Saving for retirement may feel easy when you work for someone else, particularly companies that have automatic enrollments and the employee must actively choose not to contribute to their retirement. It can be simple for entrepreneurs and small business owners to spearhead this task, too. Here’s a breakdown of the available options for retirement plans for small business owners and entrepreneurs, and the important factors to consider.
What to consider when selecting a retirement plan
The IRS offers resources on choosing a retirement plan, but key considerations include:
- Whether you have employees
- If you have employees, whether you want to contribute to their retirement accounts.
- Which is more important to you: low plan costs or higher contribution limits/loan options?
Once you have this information, consult with your financial advisor or tax professional. They will help you consider the retirement plans for small businesses and entrepreneurs that are available and help you determine the approach that’s right for you.
Traditional or Roth IRA
- Great for entrepreneurs just getting started who may not have a lot of money to contribute.
- In 2023, you can contribute up to $6,500 annually to the plan; $7,500 if you’re age 50 or older.
- Traditional IRA reduces your taxable income.
- Roth IRA is funded with after-tax dollars, but grows interest-free.
- Roth IRA has income limits- annual income must be less than $138,000. If you’re married and filing jointly you can make a full contribution if your modified adjusted gross income is less than $218,000.
SEP IRA
- An option for self-employed people or small business owners with no or few employees, according to Nerdwallet.
- The employer can contribute up to 25 percent of employees’ pretax earnings, or $66,000, whichever is less, according to the IRS. Employee contributions aren’t allowed.
- Employees don’t pay taxes on employer contributions until they take distributions from the plan when they retire.
- Employer decides each year how much to contribute to employees, depending on factors such as profitability and cash flow, according to Capital Group. You aren’t required to contribute if your business has a bad year.
- No requirement to make ongoing contributions, but what the employer does for herself, she must do for her employees.
- Can be set up even if there is only one employee, and for sole proprietors.
- Administrative costs tend to be lower than a solo 401k.
SIMPLE IRA
- For businesses with up to 100 employees.
- Can contribute up to $15,500 in 2020; $19,000 if you’re over age 50, according to the IRS.
- Employees can contribute through their salaries.
- Employers make matching contributions up to 3 percent to employees who participate, or fixed contributions of 2 percent to all employees.
Solo 401k
- An option for someone without employees, other than a spouse, according to Nerdwallet.
- The business owner is an employer and an employee, and can contribute in both capacities, according to the IRS.
- As an employee, you can contribute up to 100 percent of your income, or $22,500 in 2023; $30,000 if age 50 or older.
- As your own employer, you also can make an annual contribution of up to 25 percent of your compensation.
- Total contribution maximum to participant’s account is $66,000 or 100 percent of your earned income, whichever is less; $73,500 if you’re over age 50, the IRS states.
- May be a good choice for those who want to save a lot of money for retirement or want to save a lot in certain years when income is more than normal.
- Pre-tax dollars are used.
- There’s also a solo Roth 401k. Tax treatment is like a regular Roth.
Learn More
Now is a great time for you as a small business owner to contact a financial advisor for assistance in selecting a plan that is right for you.
The content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.
Withdrawals prior to age 59 1⁄2 may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account.
Qualified withdrawals of earnings from the account are tax- free.
Withdrawals of earnings prior to age 59 1⁄2 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax.
Limitations and restrictions may apply.
REVISED August 2023 (ORIGINAL POST July 2020)
