In order to keep this site going (at no cost to you!) this guide may contain affiliate links.
This post is from guest contributor Larry Ludwig of Investor Junkie. He’s a friend of mine and someone I’ve worked with for over two years. He’s a self-proclaimed finance nerd who loves reading and, more importantly, applying what he knows to his business and personal finances. Larry’s been featured in Lifehacker, Forbes, The Consumerist, Nerd Wallet, and the Miami Herald.
As a fellow business owner and entrepreneur, I understand how tough running a small business can be. You have to deal with lots of issues you never had to think about as an employee.
This includes compliance with the tax laws, monitoring cash flow, managing debt, getting health insurance, and trying to plan for retirement.
For most of us, the benefits and freedom of being our own boss far outweigh the financial obstacles and added responsibilities we have to face. None the less, you have to think about the future and own up to your responsibilities, because well…no one else is going to do it for you (or me!).
Know your retirement options
The first issue you’ll face when you quit working for someone else to become your own boss, is finding the best retirement vehicle for your needs and budget.
An IRA (Individual Retirement Account) is available to anyone and everyone — whether you’re a freelancer, entrepreneur, or business owner. If your yearly salary comes under the income limitations, you may still qualify for the regular IRA you had available when you worked as an employee, or you may open a new one.
But what happens if you are over the income limits of a Traditional IRA or Roth IRA? Then you will have to look for other options. In addition, an IRA has a contribution limit of $5,500 ($6,500 if over age 50) in 2015, which will limit the amount of money you can sock away for retirement.
You may have to add other investments and retirement accounts to supplement your business and personal needs enough to retire comfortably. Fortunately the government offers many more retirement options when you own a small business.
Depending on your situation, you can save up to $263,000 for retirement in just one year! To find out how, keep reading.
Choose the best savings vehicle
For the purposes of going into more depth about available retirement accounts, we’re going to talk about owning a small business as it relates to running an LLC or INC. These options don’t relate to you if you’re simply a sole-proprietor.
As a small business owner, you can choose from several different retirement vehicles, in addition to your regular IRA account.
- SEP (Simplified Employee Pension) IRA
- Solo 401(k)
- SIMPLE IRA
- Pension Plan
The first four are known as defined contribution plans. This means that a certain amount or percentage of money is set aside each year by your business for the benefit of you, the employee. In this case, you are the owner of the company, but for tax and financial purposes you’re considered an employee of the business.
Pensions on the otherhand are formally known as defined benefit plans. When you reach retirement age, you have a fixed amount of benefit from a pension.
The simplest option as a small business owner is to open a SEP (Simplified Employee Pension) IRA. It’s easy to setup and many brokerage firms have this as an option. Betterment is a favorite of mine, and recently added this as an option to their service.
Even though it has the name “IRA”, you can contribute much more money than a Traditional IRA. In 2015 you can contribute up to $53,000 or 25% of your annual salary, or whichever is lesser. Unlike Traditional and Roth IRAs, SEP IRAs have no income limits, so your business won’t be capped at earning a certain amount of money in order to qualify.
As the name implies, a Solo 401(k) is similar to a regular 401(k) in that you may have previously contributed to when you worked at your day job. Since you left your job, you can no longer contribute to your regular 401(k) which makes a Solo 401(k) the next best option.
The only limitation with this is that you and your spouse have to be the only employees of your business in order to participate. If you have other employees, a Solo 401(k) isn’t right for you.
Just like a SEP IRA, a Solo 401(k) gives you have the ability to contribute up to a total limit of $53,000 per year, and you can deposit up to $18,000 in salary deferrals ($23,000 if over 50). With profit sharing you can then deposit up to the remaining $35,000 or up to 25% of your salary compensation.
So based upon the salary deferral option of $18,000, a Solo 401(k) is usually a better deal than a SEP IRA if you earn a lower salary.
Solo 401(k) plans are slightly more complex to setup as you do need to create a document stating the rules and regulations for your company’s 401(k). There are many third-party benefit companies that ask for a nominal fee (usually under $1,000) to set up a Solo 401(k) plan.
Some firms like Vanguard and Fidelity have a plan document template you can use, which saves you the cost of creating a customized plan document.
This form of IRA is available for business owners who employ under 100 employees. You can defer up to $12,000 in salary each year, or $14,500 if the employee is over 50.
So it’s somewhat smaller in deposits than a 401(k) plan. It’s a great way to reward your employees, much like a Traditional 401(k), but somewhat easier to setup.
Though if you have that many employees, in my opinion, you might as well setup a formal 401(k) plan. You can defer at a higher amount, and brokerage firms that offer 401(k) plans are much more widely available. This could mean better service, more convenience, and less fees to maintain the plan.
Lastly, as far as defined contribution options, is the regular 401(k). A 401(k) has the exact limitations as a Solo 401(k) with the one exception that you can add more employees. If you remember, the Solo 401(k) only allows you and your spouse to participate in the plan. With a regular 401(k) this limitation is removed.
Of course, just like a Solo 401(k) a 401(k) is slightly more complex to manage. It’s a great way to defer taxes to a later date, and also reward your employees.
Pensions are typically thought of as your parents’ or grandparents’ retirement plan. You work for the same company for 30 years and at retirement, get a gold watch and a pension plan.
While pension plans have lost their popularity, it doesn’t mean you can’t create one for your small business. You can start a pension in addition to one of the other defined contribution plans listed above. This allows you to save even more tax-deferred money, which effectively lowers your current tax bill to the IRS. (And who doesn’t want to pay less taxes?!)
Depending on your age, earnings history, and tenure of service, you can save up to $210,000 per year in a pension plan. Combine this with a 401(k) and you could save upwards of $263,000 towards retirement in one year. Most small business owners will not reach these contributions and the high salary requirements to meet these limits, but it’s still good to know this option is available.
Though this sounds great for the entrepreneur who’s way behind in their retirement savings, unfortunately pensions are not without issue. Pensions are much more complex to setup and manage. They require a plan administrator to properly create one for your new company, and calculate accurate annual contributions.
The bigger issue is that pensions require a minimum amount to be deposited per year, which makes them a long-term commitment (typically 10 years). If your business varies in profits each year, a pension can be a large financial commitment that may turn out to be a curse in disguise.
Another drawback is that you’re required to make minimum deposits annually to properly fund your pension, otherwise in the eyes of the IRS it no longer qualifies as a pension.
Find out if you’re saving enough
Now that you understand the retirement options available as a small business owner, and can choose the right one for you, the next question is to find out if you’re on track. How much do you need to save to retire comfortably? Are your retirement savings on track, or will have to work longer to make ends meet?
Instead of shooting blindly, it makes more sense to keep score of your retirement progress. After all, you use accounting software to manage your business, shouldn’t you do the same for your retirement numbers?
Fortunately there’s one tool I specifically recommend that will help you determine if you’re on track and evaluate your progress. It’s called Personal Capital. It’s a free online tool where you can manage your finances, investments, and assets all in one place.
Best of all, they recently introduced their Retirement Planner service. After entering all of your assets and liabilities, Personal Capital will show you visually if you are on track towards retirement or if you have a shortfall.
Betterment also has a feature that displays whether or not you’re on track for your retirement goals, based on how much you want (or need) to save for retirement, and how much you’re currently saving each month. The Advice tab offers recommendations and tips for making sure you’re on track and are contributing enough towards your retirement future.
Either one of these free tools will show where you’re currently at with retirement planning and what you can do to better prepare your business for contributing to retirement savings.
As an entrepreneur and small business owner, it’s never too late to plan for retirement. Start with a small annual contribution, and make plans for retirement now, while you still have time on your side.
Do you own a small business? What kind of retirement plan do you participate in and why?