Retirement Planning for Small Business Owners

By on April 10, 2018

For those looking to start a new business or those who have been operating a small business for many year, perhaps you are thinking about exit plans and retirement. There are ways to turn that business into retirement income for the future.

For small business owners who face the daily pressures of running a business, the prospect of saving enough money to sustain a decent lifestyle for a long retirement can be daunting. Saving for retirement often takes a backseat to building a company whether financial times are prosperous or not.

Even though a successful small business operation may reach a significant level of profit, traditional retirement plan options do not allow the business owner to save large amounts of money in a tax-advantaged manner. Regardless, it is imperative you have a solid plan to save for the day you can no longer oversee daily operations.

To determine which retirement plan makes sense for you, you need to consider how much time you have to let your investments grow, your savings goals, any desire to access the money before retirement and, if you have employees or their participation.

Setting Your Retirement Goals and Choosing a Plan

Perhaps you have been so focused on establishing and/or running your business that you have neglected to save for emergencies or retirement. You wouldn’t be the first. If this is the case, the first step is to sit down and figure out how much you need to save each year to maintain your current lifestyle in retirement. You will need the help of a trusted financial advisor or retirement planner to run the numbers.

Determining How Much You Need to Save

Experts estimate that Americans will need 70 to 90 percent of their pre-retirement income to maintain their current standard of living when they stop working. Unfortunately, according to a recent American Express survey, about sixty percent of business owners say they are not on track to save enough for retirement.

Sketch out your retirement goals, just as you do your business goals, then put those reasonable savings goals into a compound interest calculator to determine if you would be able to retire and maintain your current lifestyle (or close to it). Don’t forget that you have the same federal contribution limits as everyone else which allow you to put away ‘x’ number of dollars per account each year, and catch-up contributions for those 55 and over.

Retirement Account Contribution Limit Catch-Up Contribution Limit
401 (k), 403(b) and 457 $18,500 $6,000
SIMPLE IRA $12,500 $3,000
SEP IRA 20% of net income(or 25% of compensation) up to $55,000 None
Individual 401(k) 20% of net income(or 25% of compensation) plus $18,000, up to $55,000 $6,000
Traditional IRA and Roth IRA $5,500 $1,000

Choosing a Retirement Plan

If you are among that group of small business owners who are trying to save for retirement while building your business there are a number of plans from which to choose, including SEP IRAs, SIMPLE IRAs and Solo 401 k plans which can maximize your tax advantages, encourage employees to contribute and plan for their retirement, reward employees who have been with the company for a minimal number of years, minimize the amount of administration required to implement and manage a plan, or minimize the annual cost of administering a plan.

But which retirement plan might be best for you? It depends on what you’re trying to accomplish. Here is a summary of three popular plans, along with advantages and considerations of each one.

SEP IRA

The Simplified Employee Pension (SEP) IRA is as easy retirement account, but it could cost your business a lot more if you have more than one or two employees. SEP IRAs are available to business owners and their employees. SEPs are especially attractive to self-employed individuals without employees.

Contribution limits on these plans are remarkably high. For the 2018 tax-filing year, the SEP IRA allows contributions up to 25% of compensation or $55,000, whichever is less. The same percentage of compensation must be made for every employee, and contributions to SEP IRAs are always 100% vested, or owned, by the employee.

Eligible employees can make traditional IRA contributions to their SEP IRAs, allowing them to exclude income from their own individual taxes. You as the employer decide if contributions will be made year to year; this gives you the flexibility to maximize contributions during years when the business is generating significant cash flow and suspend contributions in lean years.

SEP IRAs are very inexpensive and do not require special IRS filing like some retirement plans do, which makes them even more desirable for business owners. Unfortunately, you cannot pay yourself a higher contribution percentage than your employees, which means this can become an expensive option if you add employees and want to keep your own contributions high.

SIMPLE IRA

The SIMPLE IRA is a low cost retirement plan which is easy to administer for businesses with up to 100 employees or for self-employed individuals. A key benefit of the SIMPLE IRA is that it is a salary deferral plan with both employee and employer contributions. Employees can decide how much to contribute, however, you as the employer must also make contributions.

For the 2018 tax-filing year, the SIMPLE IRA allows salary deferral contributions up to $12,500, or $15,500 if age 50 or older. As the employer, you must make either a dollar-for-dollar match of salary deferrals up to 3% of a participant’s compensation or a non-elective contribution equal to 2% of each eligible employee’s compensation.

In addition, contributions that you put into an account for your employees is tax deductible as a business expense. Unfortunately, when compared with other options for employers and the self-employed, the SIMPLE IRA has very low contribution limits, which can hurt you if you are trying to catch up on savings.

Solo 401 k

For sole proprietors who want to make the highest contribution possible for themselves (and, if applicable, a working spouse), the solo 401 k is a great, low-cost option. The biggest benefit of this type of plan is that it allows for the highest contribution. As the employer, you decide whether to make pre-tax (and, if permitted, after-tax Roth IRA) salary deferral contributions and the discretionary contribution percentages.

As the employer, contributions can be made up to 25% of compensation, up to $18,000 or $24,000 if age 50 or older (2018). Thankfully, business owners have until the end of each calendar year to set up a Solo 401 k account and until the April 15th filing deadline to make tax deferred contributions.

These plans are not very expensive to set up and maintain, however, once the account reaches $250,000 the owner will have to report benefits, so it is best used in conjunction with other retirement savings accounts.

Life Insurance to Help Business Owners Retire

Unfortunately, despite all this saving, there is still a fatal flaw in the retirement plans of many small business owners: They put all their retirement eggs into one basket.

After a lifetime of investing personal energy and capital into the business, many simply hope to sell out someday for a ton of money then settle back and enjoy a financially secure retirement. Many business owners are so sure this will happen that they don’t bother to make any other retirement plans.

What if there is nobody to step up and assume responsibility for the business? Or, what if you can’t find a buyer and afford to retire? You’re stuck.

Company-owned permanent life insurance policy is one way to help protect a small business from financial problems caused by the unexpected death of a key employee, co-owner or potential successor, as well as to help fund buy-sell agreement. If the covered individual dies, the proceeds from this type of insurance can help in several ways.

The Buy-Sell Agreement

A buy-sell agreement specifies ownership transfer options if an owner or a key person leaves the company, dies or becomes disabled. The death benefit from a life insurance policy can be used to purchase the interest in the company from his or her heirs.

Keeping the Cash Flowing

The company can withdraw or borrow insurance cash values from a permanent policy as needed, and it will receive a tax-free death benefit upon the employee’s death. The death benefit can be used to replace lost business income or to pay operational costs when a key employee or owner is suddenly gone, including rent, utilities, lease payments, and payroll.

Plan for the Future an Entrepreneur Deserves

Consider establishing a retirement plan for you and your business today. By doing so, you’ll not only save more money for your own retirement, but hopefully keep most of your income from falling into the hands of the government. Speak with your trusted financial advisor, tax preparer and retirement planner to help you establish the best plan to meet your needs.

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About Kendrick Lee

Senior writer and business columnist for FSN - Successful businesses, large or small, will lend to successful owners, employees, local communities and markets for continued economic growth. Since there are so many risks, finances and procedures to consider when running a business, Kendrick is dedicated to sharing business tips, strategies and ideas in the public sphere. Find Kendrick on !

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