Being fully committed to building your business doesn't mean you should ignore saving for retirement. Learn about available self-employed retirement plans.
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.
These same attributes—if applied toward your own personal financial interests—can help you establish a safe and sound financial future. 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. 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. You can put money away, even minimally, into a retirement plan. Here are five plans designed specifically for small business entrepreneurs just like you.
Annual Contribution Limit: The lesser of 25% of net self-employment income or $55,000 for 2018.
SEP IRAs give you the advantage of high annual contribution limits, low setup costs, and minimal paperwork. 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.
Even those with merely a side gig could consider SEP as a way to potentially reduce their taxes on their side gig income, while saving for retirement. In addition, an SEP gives you and your employees a wide variety of investment options.
Caveats: If you have employees, all of them must be included in your SEP retirement plan 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.
Annual Contribution Limit (2018): $55,000, or $61,000 if you are age 50 or older; your spouse, if he or she is your employee, can contribute up to $18,500 in salary deferrals or $24,500 if he or she is age 50 or older.
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: eligible 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, if a loan provision is offered in the plan document.
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. Your Solo 401(k) may permit the salary deferrals to be federally pre-tax or to be Roth deferrals. Roth deferrals are always taxed up front but the earnings are tax-free in retirement.
401(k)s are the only business retirement plan that are permitted to offer this Roth contribution option. When comparing, say, a SEP IRA versus a solo 401(k), it’s important to consider the eligibility rules and limitations.
If you’re under age 50, don’t need a loan from the plan, and would be able to contribute the full amount desired to the SEP, then Solo 401(k) might not be worth the extra work. Once your assets reach $250,000 in the Solo 401(k) you’ll have to make IRS Form 5500 filings.
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 sometimes make other qualified plans onerous. 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. If you’re weighing the pros and cons of a SEP IRA versus a SIMPLE IRA, employees being able to contribute for themselves may be a factor to consider. That said, if you stick with a solo 401 (k), you’ll still have a large set of investment options.
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 they made a salary deferral contribution. You’ll need to coordinate with payroll to make at least monthly contributions to the plan, as employee salary deferrals must be submitted timely. This may have a significant impact on your bottom line if your business is having a bad year. On the other hand, 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.
Annual Contribution Limit (2018): $5,500, or $6,500 if age 50 and older.
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 or SEP 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.
Annual Contribution Limit (2018): The lesser of 25% of compensation, or $55,000.
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, and are tax-deductible. And like a solo 401(k) plan, with a profit sharing plan you can offer loans of the plan account balances (up to the legal limits of course). Unlike a SEP IRA, you can have a vesting schedule, so employees who leave your company before five years would not be able to take away all the money you contributed for them. This may encourage longer-term employees. You may also require that employees work at least 1000 hours in a year before they become eligible for a plan contribution.
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. But many profit sharing plans are very simple and merely require that each employee receives a contribution based on a percentage of their salary. 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.
In bad years your business can reduce the percentage contributed for employees or stop completely. While the plan is meant to continue for more than just a year or two, variability in contributions is permitted. Of course, in years without profit sharing contributions, you and your employees might consider making contributions to their own personal IRAs.
Bottom line? A self-employed retirement plan is likely within reach. And whether your business is large, small, or in between, there are several retirement plans that are designed to work for your company.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
Maximum contribution limits cannot be exceeded. Contribution limits provided are based on federal law as stated in the Internal Revenue Code. Applicable state law may be different. TD Ameritrade does not provide legal or tax advice. Please consult your legal or tax advisor before contributing to your IRA.
See which small business retirement plan may be right for you and your employees.
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