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Grow Your Business Finances

Retirement Plan Options for Small Business Owners

Retirement Plan Options for Small Business Owners
Credit: vinnstock/Shutterstock

You may be decades away from retirement age, but as a small business owner, it's important to plan for your future today. According to the U.S. Department of Labor, you're going to need 70 to 90 percent of your pre-retirement income to maintain your current standard of living, and you won't be able to accumulate that if you don't start saving now.

Setting up a retirement savings plan won't just benefit you — it can help you attract top talent to your company. Numerous studies have shown that a retirement savings plan offering is a big draw for job seekers. In fact, a recent Schwab survey found that 87 percent of workers who currently participate in a 401(k) plan consider their retirement plan a "must-have" employer benefit.

If you think your company is too small or doesn't have the resources for a formal retirement plan, think again. Whether you're managing multiple employees or just work for yourself, there's an affordable plan option out there that's right for you.

"There are a number of choices available for both, as well as a range of service providers that offer the supporting tools and guidance necessary to select the best options to meet a range of retirement saving needs," said Terry Dunne, managing director of automatic rollovers at financial services company Millennium Trust.

If you're interested in setting up a retirement savings plan for your company, here are the most common types of plans available for small business owners and self-employed individuals.

Editor’s Note: Considering an employee retirement plan for your business? If you’re looking for information to help you choose the one that’s right for you, use the questionnaire below to have our sister site, BuyerZone, provide you with information from a variety of vendors for free:

In a self-directed or personal Individual Retirement Account (IRA), the account owner directs all investment decisions on behalf of the retirement plan, while a qualified trustee or custodian holds the IRA assets on behalf of the IRA owner. Dunne noted that individuals who have left a job and want to move retirement funds from their former employer's 401(k) plan typically choose to roll over their assets into an IRA. 

When considering a self-directed IRA, there are two types to choose from: traditional and Roth.

Traditional IRAs allow annual tax-deductible contributions that depend on the individual's modified gross adjusted income. Withdrawals are taxed, but earnings on principal and interest accumulate tax-deferred until funds are withdrawn from the account penalty-free after age 59 and  a half, and minimum required distributions are mandatory after age 70 and a half. Dunne noted that the traditional IRA is a good choice for individuals whose tax strategy is to defer taxes until after retirement, or for those who anticipate that tax rates during their retirement will be lower than their current rate.

Roth IRAs have distinct tax benefits, Dunne said: Earnings from a Roth IRA accumulate tax-free, and unlike a traditional IRA, withdrawals are free of tax and penalties, provided certain conditions are met. Contributions are not tax-deductible, but can be made past age 70 and a half.

Employer-sponsored IRAs work for small business owners who would like to offer retirement benefits to current employees, or to potentially attract new hires through benefits packages. There are two options for employer-sponsored IRAs: Simplified Employee Pension IRAs (SEP IRAs) and Savings Incentive Match Plan IRAs (SIMPLE IRAs).

SEP IRAs allow employers to make contributions to their employees' retirement accounts of up to 25 percent of the employee's compensation, or a maximum of $52,000 in 2014, whichever is less, Dunne said. They are also funded 100 percent by the employer; employees do not contribute. The employer is not required to make a contribution every year but must contribute the same percentage for employees that they may contribute for themselves in a given year. Peter Calfee, president of Calfee Financial Advisors, said that SEPs are the easiest plans to set up, and offer business owners the greatest flexibility in when and how much they contribute.

SIMPLE IRAs enable employers with fewer than 100 employees to establish an IRA for each participating employee. The SIMPLE IRA has requirements similar to a traditional IRA, but with this plan, employees can make salary deferral contributions of up to 100 percent of their compensation, not to exceed $12,000 in 2014. As their employer, you must also contribute to their accounts, Dunne said. You can either match your employees' contributions dollar for dollar for up to 3 percent of their compensation, or contribute 2 percent of each eligible employee's compensation.

Perhaps the most well-known type of retirement plan, a traditional 401(k) allows employees to contribute a portion of their wages to individual accounts. Employers have the option to make and/or match contributions on behalf of plan participants, and have the right to reclaim those contributions if an employee leaves the company before a set time. Additionally, employers who sponsor traditional 401(k) plans are subject to an annual qualifying test by the IRS.

Unless employees contribute to a Roth 401(k) account, money is taken out of an employee's wages pretax and therefore reduces the amount of income tax he or she has to pay. Because of this, the IRS places a cap on how much an employee can put into a 401(k) account each year. Andrew Meadows, consumer and brand ambassador at Ubiquity Retirement + Savings, formerly known as The Online 401(k), said that the IRS has raised its annual contribution limit from $17,500 to $18,000 for 2015.

There are several other types of 401(k) plans available aside from the traditional one described above, and it's important to understand the features of each one before choosing a plan for your business.

Solo 401(k) plans are similar to self-directed IRAs. However, these plans are suitable only for single-employee businesses, since only the business owner and his or her spouse may participate and make contributions to the plan. The plans also offer more generous annual contribution limits than any of the other options, and tax-deferred contributions can be up to three times that offered by other plans, Dunne said.

Safe Harbor 401(k) plans mandate that employer contributions must be vested as soon as they are made. Therefore, employees are able to take the money with them when they leave the company, regardless of how long they have been there. Safe Harbor plan sponsors are not subject to the annual IRS test.

Simple 401(k) plans are ideal forsmaller ventures, as they can only be offered by businesses with fewer than 100 employees. Like the Safe Harbor plan, the Simple plan requires employer contributions be vested as soon as they are made and does not mandate annual testing.

Meadows cautioned business owners to read the fine print when setting up a 401(k) plan, since many providers will tack on hidden fees.

"A lot of employees think a 401(k) plan is free, but their savings are being eroded by a fee off the back end," Meadows told Business News Daily. "Take a look at the funds and see how much you're actually paying. Administrative costs might be low, but you may find that [there are] low balances in the 401(k) accounts [due to] hidden fees."

For more detailed information on the types of 401(k) plans available, visit Business News Daily's reference article on the subject.

Any employer with one or more employees who have worked at least 1,000 hours in a previous year can offer a profit-sharing retirement savings plan. The Department of Labor states that the maximum annual contribution for this plan is up to $51,000 or up to 100 percent of an employee's compensation if below $51,000. More so than other defined contribution plans, a profit-sharing plan gives the employer the advantage of making large contributions for employee.

 

Before deciding on a plan provider, it is import for individuals and small business owners to determine what kinds of investment options they would prefer to have. Dunne advised employers to ask themselves these questions before they decide on a retirement plan:

  • Do you prefer simple administration?
  • Do you expect to have employees?
  • Is it critical that your employees be able to contribute to the plan?
  • Will it be important to attract and keep good employees?
  • Do you want to maximize your contributions?
  • Will you want to contribute every year?
  • Do you want plan contributions to be deductible as a business expense?

Your answers to these questions can help you better evaluate which plan works best for your business. It's also important to speak with a professional, such as an accountant, lawyer or financial planner, to determine what your business needs versus how much it can afford.

"Start by interviewing folks who are knowledgeable," said Marilyn Capelli Dimitroff, principal and director of wealth management at Planning Alternatives wealth advisory firm. "It's something that most small business owners don't deal with on a day-to-day basis. The skills that make you a good entrepreneur may not equip you to manage investments on an on-going basis"

Additional reporting by Brittney Helmrich, Business News Daily Staff Writer.

Originally published on Nov. 16, 2014. Updated Dec. 16, 2014.

Nicole Fallon
Nicole Fallon

Nicole Fallon received her Bachelor's degree in Media, Culture and Communication from New York University. She began freelancing for Business News Daily in 2010 and joined the team as a staff writer three years later. She currently serves as the assistant editor. Reach her by email, or follow her on Twitter.