Small business owners and gig economy workers enjoy enormous freedom and flexibility. However, they miss out on full-time employee benefits, particularly the retirement plans and contributions many workers enjoy. Still, small business owners must plan and prepare for retirement in the absence of company-sponsored plans. We’ll highlight several types of individual retirement accounts and 401(k) plans that anyone can access and share tips on saving for retirement if you have your own business.
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As a self-employed person, you have five primary retirement account options. Here is what you need to know about each one.
First, consider opening a SEP IRA plan, which allows you to pack away significantly more money than traditional IRAs allow. The amount of money you can put into your SEP is based on your earnings. Whereas with a traditional IRA, you can only put in $7,000 if you’re under age 50 (for 2024), you can contribute up to $69,000 or 25 percent of your earnings ― whichever is less ― with a SEP.
“A SEP is highly desirable because it’s easy to achieve,” explained Angela Park Sheldon, managing partner and wealth advisor at Tortuga Wealth Management. “You don’t need a third-party administrator. You can open a SEP IRA and start saving immediately.”
However, with a SEP IRA, only the employer contributes. If you’re a business of one ― say, a freelancer ― this is a no-brainer. However, if you’re a business with 10 employees, your contribution rate must be the same for all employees and you’re the only contributor to the account ― your employees cannot contribute. This is where things can get more complicated and hiring a plan administrator is highly recommended.
The solo 401(k), also known as a one-participant 401(k), allows you to make contributions to your retirement account as both an employer and employee. You can contribute up to $23,000 for 2024 ($30,500 for age 50 or older) as well as 25 percent of compensation for employer contributions, maxing out at $69,000 per year ($76,500 if you are 50 or older).
For a single, self-employed individual, you must calculate how much you can contribute, but you’ll typically benefit far more than you would from a SEP IRA, saving much more money and significantly reducing your business owner or sole proprietor taxes.
A SIMPLE IRA is a retirement account through which employees and employers can contribute to a traditional IRA (whereas SEP IRAs only permit employer contributions).
Any business with 100 employees or fewer can set up a SIMPLE IRA. If your business is a sole proprietorship, you are both the employer and employee, so you, too, qualify for SIMPLE IRAs. In this case, all your annual self-employment net earnings are valid for investment in your SIMPLE IRA.
If you choose a SIMPLE IRA, you must meet one of two annual contribution requirements for each of your employees:
Those under age 50 may contribute up to $16,000 per year to a SIMPLE IRA; those older than age 50 may contribute $19,500 per year. Additionally, SIMPLE IRAs may be combined with another employer-sponsored retirement plan. Your total contributions across these two plans must not exceed $23,000.
A Roth IRA is a retirement plan in which investments grow tax-free and withdrawals during retirement are also tax-free. You pay taxes when money is invested into the account; your contributions are not tax-deductible.
Setting up a Roth IRA is possible, but it’s significantly more challenging than offering the other types of retirement accounts listed here. Instead, the role of Roth IRAs in retirement savings for business owners should be for you to open these accounts entirely outside your company books and treat them as you would a personal retirement plan.
A traditional 401(k) is appealing ― you can make employee deferrals, plus anyone over 50 can play catch-up with additional contribution allowances. However, before going this route, consider what will benefit your employee base most. Do they understand the benefits of a 401(k) and are they willing to contribute? Is this a benefit they want?
Some business owners may want to consider a safe harbor 401(k) plan. These plans are designed to ensure no employee is discriminated against. Safe harbor plans do not have to undergo the annual nondiscrimination tests, usually required by law, that evaluate how employees of various compensation levels use your 401(k) plans.
Now that you know about the various types of retirement plans, follow these tips to make the best of your retirement account and prepare for retirement as a small business owner.
Just like your business, the best employee retirement plans can be more complex than they appear. Hiring a certified financial planner (CFP) and a third-party administrator is a smart investment in the longevity of your business.
“It’s a good idea to find someone from a referral,” Sheldon noted. “Find someone who has had many years of experience.”
It’s not uncommon to see business owners want to save the money they would spend on a retirement strategy and use it for other things, including putting it back into the business. However, similar to how it’s critical to hire a reputable bookkeeper or attorney, small business owners should spend the money and hire an experienced CFP ― someone who is trustworthy and who will support your business as you grow.
Experienced professionals can advise you on your unique situation and goals and construct a strategy for you based on various plans.
When it comes to retirement savings for business owners, don’t put all your eggs in one basket. If you choose to launch SEP or SIMPLE IRAs for you and your team, don’t be afraid to start your own personal traditional or Roth IRA. Doing so diversifies your portfolio. If one of your accounts includes more stock investments than another during an economic crisis, not all of your investments are impacted equally.
Some retirement plan providers offer plans aimed at small business owners. These plans should comprise at least a portion of your retirement savings strategy, as they may have features that are friendly to small business owners that other retirement accounts lack. Retirement savings for business owners can mean looking at opportunities meant not for everyone but for people like you whose business ownership presents unique saving challenges.
Small business owners may think that selling their business will set the foundation for their retirement plan. However, this strategy can become complicated, especially in family-owned and operated businesses. The company’s direction can get tricky with so many passionate owners involved.
“The idea of selling your business when you retire is great in theory,” Sheldon explained. “But you are likely not going to get the value out of it that you are hoping for. If you do, great. But planning for it is not a great exit plan. You don’t want to play games with retirement.”
Retirement planning is different for everyone. “There is no one-size-fits-all,” Sheldon said. “It’s not like typical budgeting. Everyone has a different time horizon, risk tolerance and lifestyle. Each of these factors matters.”
Retirement is personal. Business owners must consider other factors, including new jobs or ventures, travel opportunities, spending time with family, dealing with health concerns and more. However, with smart planning and conservative choices, business owners can have a lot of flexibility.
“The millionaire next door is real,” Sheldon shared. “I have clients who retire early, who earned a modest income throughout their careers. They just made wise choices and investments. And now they can securely retire for a modest amount per month. It’s amazing to see.”
Max Freedman contributed to this article. Some source interviews were conducted for a previous version of this article.