The responsibilities of owning and operating a small business can be overwhelming at times. Every decision - from choosing printer paper to putting together a budget, creating a business plan, and looking for funding - is yours and yours alone. With so much to act on and think about just to keep your business in the black, it's easy to shunt aside longer-term planning
Still, there are long-term planning issues that are critical to your personal success as a small business owner, and they aren't going away, particularly when it comes to planning for your retirement. You don't have the luxury of an employer offering a 401(k) or pension plan, complete with a selection of appropriate investment vehicles, to ensure your financial future. It's all up to you.
Too many small business owners avoid the crucial elements of planning for their futures. Manta, an online resource dedicated to helping small businesses promote themselves and gain new customers, surveyed nearly 2,000 small business owners in 2017. Manta found that over a third (34%) of those surveyed don't have a retirement plan. Among this group, the reason most commonly cited (by 37% of those respondents) was that they're simply not generating enough revenue to save. Another 18% of the business owners without retirement savings are looking at selling the businesses as the retirement plan.
A similar study conducted by the Guardian Insurance Company offered even more marked results, with 35% of small business owners surveyed reporting that they actually started their businesses to fund their retirements. In answer to a separate question, 35% of respondents said they were depending on income from the sale of their businesses to retire.
We're all familiar with the old adage about the dangers of putting all your eggs in one basket, and this is a textbook example. There's plenty that could go wrong in this scenario. A business will only sell if it can continue to operate as a going concern. Is there a succession plan in place that will insure business continuity? And don't forget market conditions, which determine if a business can be sold at an attractive price. The last thing any entrepreneur wants is to be forced into divesting at a fire-sale price. If you don't have a retirement plan, you could easily find yourself forced to sell under less-than-optimal circumstances.
Further confusing the issue of retirement funds in 2018 are new tax laws approved by Congress at the end of 2017. Prior to passage of the GOP tax plan, many feared how the changes to the tax law could impact retirement funds and 401(k)s in particular. However, the new rules do not change existing retirement savings incentives. The rules around 401(k)s, IRAs, Roth IRAs and other retirement savings accounts will not change as a result of the new tax rules.
One thing the law does change is the Roth IRA characterization option. However, this change starts in 2018; Roth IRAs recharacterized in 2017 will still be allowed.
There are a number of retirement solutions that can help you secure your future and that of your employees, but the decision-making process can be challenging. Even retirement and investment professionals can have a hard time determining the best option for a small business owner. Here are a few questions to ask yourself before deciding on a retirement plan:
- Do you have employees or expect to in the future?
- Is it important that employees are able to contribute to a retirement plan?
- Is your priority higher contributions or ease of administration?
- Would you like plan contributions to be deductible as a business expense?
We looked at a number of different plans, including the: Simple IRA, the SEP IRA, the Self-Employed 401(k), the Simple 401(k), and the Roth IRA. We compared the various features, and spoke to both small business owners and professionals in the retirement field. Kwame A. Michel, an Atlanta-based accountant who specializes in working with small business clients, noted that the SEP IRA is the most popular retirement savings option among his small business clients. "The low fees, combined with a minimal administrative burden and lower maintenance requirements, make it a popular option." He notes that the solo 401(k) runs a close second, and many clients, particularly those focused on growing their businesses, appreciate the flexibility of being able to borrow against the assets.
With this research in mind, here are our suggestions for the best retirement vehicles for small business owners.
Solo 401(k): Best Retirement Plan for Maximizing Contributions
If you're self-employed or a business owner with no employee other than your spouse, you're eligible to establish a self-employed 401(k). Also known as the solo 401(k), this is the retirement plan of choice for business owners who want to maximize their contributions to their retirement plans. The plan is suitable for sole proprietors, partnerships, C corporation and S corporation business owners. This plan offers the greatest possible contribution among retirement plans as it recognizes that you are both employer and employee. As an employee, you can contribute up to 100% of compensation, up to the annual contribution limit of $19,000 in 2019. If you're 50 or over, that goes up to $25,000. Plus, you can make the employer contribution of up to 25% of compensation for a total maximum contribution of $54,000. Note that the total employer/employee contributions cannot exceed $56,000 for 2019. If you are over the age of 50, you can add in the catch-up contributions of $6,000 increasing your total up to $62,000 for 2019.
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The plan offers tax-deferred growth. If the business is incorporated, contributions are considered a business expense. If the business is not incorporated, the business owner can deduct contributions for him- or herself from personal income. The only disadvantages of this plan are that it may be slightly less convenient, as a plan administrator is required. Once plan assets reach $250,000, you'll also have to file a Form 5500 with the IRS.
SEP IRA: Best Retirement Plan for a Sole Proprietor Who Wants Easy Administration
The Simplified Employee Pension (SEP) IRA is an excellent choice for the sole proprietor who wants to save for retirement with a minimum of administrative headache. Unlike the Solo 401(k), a SEP IRA can cover employees, thus allowing greater scope for business growth. The plan is easy to setup and maintain, and there are no setup fees or annual charges. These plans are completely employer funded, and employees make no contributions. For 2019, the employer can contribute up to 25% of compensation to a maximum of $56,000. Note though, that a SEP can become expensive if you want to save aggressively. While you as an employer are not required to make a contribution every year, you must contribute the same percentage for employees that you contribute for yourself.
SIMPLE IRA: Best Plan for Employee Participation in Funding the Retirement Account
The Savings Incentive Match Plan (SIMPLE) IRA allows businesses with fewer than 100 employees to establish an IRA for each employee. Employees are allowed to make salary deferral contributions of up to 100% of compensation, or no more than $13,000 in 2019. Employees over the age of 50 may also make a $3,000 catch-up contribution for a total of $16,000. The employer also contributes to the account, either matching employee contributions dollar-for-dollar up to 3% of compensation, or contributing 2% of each employee's compensation. Advantages to this option include easy setup and few administrative burdens. The contribution limits are also more generous than those allowed for the traditional or Roth IRA. However, contributions to this account are considered "elective deferrals" that count toward an individual's overall annual limit on elective deferrals.
While these plans are three of the most effective for small businesses, we took a look at two others as well.
The SIMPLE 401(k) is an alternative for companies that have fewer than 100 employees and wish to avoid the administrative burden of a standard 401(k). Employees can elect to contribute, but unlike a regular 401(k), you as the employer are obligated to make a matching contribution up to 3% of each employee's salary, or a non-elective contribution of 2% of each employee's salary. While the employer is obligated to file a Form 5500 each year, the administrative burden is significantly lower as the company is not required to perform expensive non-discrimination testing as it would be with a regular 401(k). One feature that could make the simple 401(k) less attractive to companies is that contributions made into the account vest immediately, thus negating a staged vesting plan's employee retention benefit.
For a sole proprietor, a Roth IRA can be used to supplement retirement savings, provided that income falls under the ceiling of eligibility. It's possible, for example, to fund a SEP or SIMPLE IRA and a Roth IRA. Contributions to the Roth IRA are made from after-tax income, and therefore assets held within the account grow tax free. Distributions are tax-free as well. The big drawback to the Roth IRA is that it's limited on the basis of income and thus not accessible to high earners. Contributions to the Roth IRA phase out completely for single filers at an annual income of $133,000, and for joint filers at an annual income of $196,000. Annual contributions are capped at $5,500, or $6,500 for individuals over 50.
At the end of the day, owning and running a small business can be an all consuming endeavor. Things like retirement planning can fall to the wayside amid more pressing concerns, like paying the bills, yourself and growing the business. But someday, like all things, your days as a small business owner will come to an end, and after a successful run (hopefully), you'll retire. The time you invest now into retirement planning is critical, especially because of your status as a small business owner. Like all things related to running your business, when it comes to retirement planning, chances are if you don't do it, it simply won't get done.
Prior to 2018, it was possible to undo a Roth IRA conversion through the process of recharacterization. This was helpful for people if the value of converted investments had decreased over time. However, the practice of recharacterizing Roth IRAs ended at the conclusion of 2017 with the passage of new tax laws by Congress. Roth IRAs recharacterized in 2017 are still permitted, but you cannot recharacterize a Roth IRA in 2018 or beyond. It's important to keep this in mind when contemplating retirement plans for small businesses in 2018.
This article was updated February 2, 2018 and on September 23, 2109