As a small business owner, you may feel it’s your job to help your employees plan for retirement. However, it’s also important for you to have a plan in place after you stop working. Over one-third of small business owners don’t have a retirement plan, but most people need at least 70% of their pre-retirement income to maintain the same lifestyle after retiring. In this blog, we’ll explore small business retirement planning to help you start saving early and preparing for your future.
What Is a Small Business?
According to the Small Business Administration, there’s no one-size-fits-all definition of a small business. This is because the number of employees and revenue varies greatly based on industry. Small businesses include sole proprietorships, privately-owned corporations, and partnerships that earn less than larger businesses. There are nearly 30 million small businesses in the U.S. and they play a key role in our national economy.
Always Pay Yourself First
While you may think putting everything you earn back into your business will secure your retirement, the future is rarely a given. You should always pay yourself a salary, even if it isn’t necessarily as much as you’d like.
Having a specific figure in mind when preparing for retirement is also extremely important. This number should be part of your budget, and you should put money towards it every month alongside your other expenses. It can be a small amount if your business is new, but it should steadily increase as you become more profitable.
Select the Right Retirement Plan
Choosing the right small business retirement plan for you and your employees (if applicable) is also key to a comfortable retirement. There are many tax benefits to employee retirement plans, including:
- Employer contributions can be deducted from your income
- Employee contributions aren’t taxed until distribution (with the exception of Roth plans)
- Your money grows tax-free
- Distributions may be eligible for tax-favored rollovers into other plans
Simplified Employee Pension (SEP) IRA
A SEP IRA is one of the most popular small business retirement plans on the market. This is because you’re considered an employee and can make employee contributions to your own account. Here are a few more pertinent details about SEP IRAs:
- You decide how much your employer contribution will be on an annual basis and aren’t locked into a fixed amount.
- Your employees won’t pay taxes on the amount you contribute until they retire and begin receiving distributions.
- You must contribute an equal percentage of salary for each participating employee.
- Employees can make pre-tax contributions of up to 25% of their income or $57,000 (whichever is less) up to $285,000.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
Many small business owners opt for a SIMPLE IRA, which has contribution limits that are significantly lower than SEP IRAs. Here’s what else you should know about SIMPLE IRAs:
- You can match contributions up to 3% of each employee’s salary or contribute 2% of each employee’s pay up to $285,000.
- Employees under 50 can contribute up to $13,500 of their pre-tax salary.
- Employees over 50 can contribute up to $16,500 through a $3,000 catch-up contribution.
- Early withdrawals made before age 59 ½ are taxed as income and subject to a 10% penalty.
- Withdrawals within the first two years of enrollment are subject to a 25% penalty.
Traditional or Roth IRA
Some small business owners choose traditional or Roth IRAs because they can enroll even if they don’t have employees. These IRAs are also a smart choice if you don’t offer retirement benefits to your staff, but still want to save for your own retirement.
With a traditional IRA, employees under 50 can contribute up to $6,000. Employees over 50 can contribute up to $7,000 via a $1,000 catch-up contribution. Your money goes into your account pre-tax, and you pay tax on the distributions.
With a Roth IRA, you contribute money you’ve already paid taxes on, which means you’ll receive tax-free distributions. However, your retirement tax bracket may be higher as a result. There are also income limits that determine whether you can open an account.
One Participant / Solo 401(k) Plan
These 401(k) plans are specifically intended for business owners without eligible employees. Like most non-Roth retirement plans, you’ll contribute pre-tax dollars and pay tax on your distributions. However, a Roth version of a solo 401(k) is also available. Solo 401(k)s have a $57,000 contribution limit (plus a $6,000 catch-up for those over 50) or 100% of your earned income, whichever is less.
If You Choose to Sell Your Business
Studies show that 35% of small business owners plan on selling their business to fund their retirement. However, this can be a potentially risky business exit strategy. While selling your business can certainly supplement your retirement plan, it shouldn’t be your entire plan. In fact, it’s never too early to start thinking about finding the right buyer.
Selling a small business may be easier during an economic upturn, but you should be prepared to work longer if there’s a recession. You should also account for buyers who can’t obtain financing right when you’re ready to sell. Additionally, you may need to alter your timeline due to factors that are beyond your control, such as health or family issues.