As an entrepreneur, you possess the enterprising go-ahead to bear risks in pursuit of a long-term vision; the ingenuity to seize potential within even the smallest of actions; and the forward-leaning tenacity to build a robust business on nothing more than an idea, passion, some starting capital, and lots of moxie.
Interestingly, these same attributes—if applied toward your own personal financial interests in contrast to your business endeavors—can help you establish a safe and sound financial future. With that said, it’s somewhat ironic that despite possessing these qualities, many entrepreneurs focus on their businesses at the expense of their own long-term financial health. In fact, according to a 2017 survey by small business portal Manta, 34% of self employed people don’t have a retirement savings plan!
Sure; you have your reasons. No time to plan. No time even to research the available alternatives. And besides, every available dollar is being plowed back into the business. You might think that, as a self-employed entrepreneur, a retirement plan would need to be of a sizable amount in order to be worth the time and trouble.
Fortunately, this is not the case. And yes, you can put money away, even minimally, into a retirement plan. Over the years, the retirement industry has become attuned to these needs and has responded with a few retirement plans for small business owners just like you. Here are five of them.
1. SEP IRA (Simplified Employee Pension IRA)
Annual Contribution Limit: The lesser of 25% of net self-employment income or $54,000 for 2017 ($55,000 for 2018).
SEP IRAs give you the advantage of high annual contribution limits, low setup costs, and minimal paperwork and tax filing requirements. You also have the flexibility of varying or even skipping your contributions based on the needs of your business. Although there are no catch-up contributions, the high limits should be adequate enough to compensate. Overall, it can be an attractive retirement vehicle for sole proprietors, whether you work solo or have employees.
Caveats: If you have employees, all of them must be included in your SEP setup if they meet the IRS’s eligibility requirements. Each employee must also receive the same contribution percentage that you give yourself. And finally, all contributions are to be made by you, the employer, which can mean higher costs. But all the contributions - even for employees - are tax deductible.
2. Solo 401(k)
Annual Contribution Limit (2017): $54,000, or $60,000 if you are age 50 or older; your spouse, if he or she is your employee, can contribute up to $18,000 in salary deferrals or $24,000 if he or she is age 50 or older. For 2018, the limits increase to $55,000; $61,000 for those over 50. Also for 2018, the $18,000 and $24,000 limits increase $500 to $18,500 and $24,500.
If you work for yourself, or if your spouse is your sole employee, you may be eligible for a solo 401(k) plan. Solo 401(k)s offer several potential advantages over other retirement vehicles: annual contribution limits are higher than most retirement account types; multiple investment choices—stocks, funds, and bonds—are more robust than standard corporate 401(k) plans, many of which are limited to mutual funds; and employer contributions via profit sharing can be combined with employee contributions. The solo also allows you to borrow against your savings.
Caveats: If you plan to add profit sharing to your spouse’s contributions, your profit sharing limits may be affected. Profit sharing contribution limits also vary depending on whether you own a sole proprietorship, corporation, or partnership. And finally, in some states, salary deferral contributions to solo 401(k) plans are not deductible pre-tax for state tax purposes. If it's a Roth Solo 401(k), however, salary deferrals are always pre-tax for Federal purposes.
3. SIMPLE IRA (Savings Incentive Match Plan for Employees IRA)
Annual Salary Deferral Contribution Limit: $12,500, or $15,500 if age 50 and older, for both 2017 and 2018.
For businesses with 100 or fewer employees, the SIMPLE IRA aims to offer a less cumbersome salary deferral solution than qualified plans such as 401(k), 403(b), and 457 plans. It’s typically easier to set up and doesn’t involve the same degree of bureaucratic processes and paperwork that make other qualified plans onerous. SIMPLE IRAs also offer multiple investment choices—stocks, mutual funds, and bonds. Although the annual contribution limits are lower than some other plans, employees may benefit from the immediate vesting that applies to their contributions and employer matches regardless of their tenure with your company.
Caveats: The plan’s mandatory employer contributions mean that you must match up to 3% of employee contributions dollar for dollar. Alternatively, you could choose to contribute 2% of pay for all eligible employees, whether or not that made a salary deferral contribution.This may have a significant impact on your bottom line if your business is having a bad year. Although, contributions are tax deductible to your business of course. Plus, your own contributions, like those of your employees, are much lower than most other retirement plans.
4. Traditional IRA
Annual Contribution Limit: $5,500, or $6,500 if age 50 and older, for both 2017 and 2018.
The main advantage of a traditional IRA is that you may be able to deduct your contributions. Because your deduction is claimed as an adjustment to your income, you can claim your tax break regardless of whether or not you itemize. Depending on your income, you may even be able to contribute to both a traditional IRA and a small-business retirement plan, getting a tax deduction for each. Any contributions you make, whether deductible or not, will be able to grow tax deferred.
Caveats: One potential downside is that if your spouse puts money in an employer-sponsored plan, and if your modified adjusted gross income is too high, you may not be able to deduct your contributions. In that case, consider opening a Roth IRA instead, if you meet the eligibility requirements. Another downside concerns the early withdrawal penalty of 10% if you take money out of your account before the age of 59 1/2. There is no general hardship exception, but there are exceptions for buying your first home, particular types of medical expenses, and higher education expenses.
5. Profit Sharing
Annual Contribution Limit: The lesser of 25% of compensation, or $54,000 for 2017 (increases to $55,000 for 2018).
We covered profit sharing in a solo 401(k) context, one in which your business has one employee—your spouse. But profit sharing is a scalable incentive; its operations are more commonly found within larger companies. If you have several employees, you can allocate a percentage share of your revenues. In fact, you can offer profit sharing in addition to other retirement plans, and regardless of the size of your business, and regardless of whether you actually have profits. You just have to file IRS Form 5500. The advantage of profit sharing stems from its underlying goal and assumption: that employees will feel more incentivized to perform when company profitability translates directly into greater net income. Contributions are made by you for your employees. Unlike a SEP IRA you can have a vesting schedule, so employees who leave your company before 5 years would not be able to take away all the money you contributed for them. This may encourage longer term employees. But it does have its caveats.
Caveats: For starters, your business will make all contributions for employees (and to your own account). In general, the contribution must be the same percentage for all employees, although some plans allow you to contribute more for older workers. Some advanced plans allow special contribution categories, but there are strict legal rules and you would need to find an administrator to handle this type of profit sharing plan.
Another caveat is one in which a business is having a bad year. While the business can discontinue contributions, employees would not be getting additional retirement contributions for that year, so they would need to make their own personal IRA contributions.
Bottom line? A self-employed retirement plan is likely within reach. if you’re a business owner, whether large, small or in between, there are several retirement plans specially designed for small business owners.
Regardless of your age, saving for retirement should typically be a priority in your overall financial plan. How much do you need to save to reach your retirement savings goal?