Retirement plans for businesses may cover your employees and you. In fact, it’s generally common investment advice to open a retirement account to which both you and your team are able to contribute. There are additional steps you should consider taking as you strategize your retirement savings. Below, learn more about small business owner retirement plans and saving for retirement.
Do small businesses have retirement plans?
According to a 2022 ShareBuilder® 401k survey of 500 small business owners, 26 percent of small businesses offer retirement plans. However, a 2020 JPMorgan® survey of 590 small business owners found that 48 percent offer retirement plans. No laws require small business owners to offer retirement plans, however, doing so is typically beneficial enough that you should still consider it.
You can typically set up a retirement account with the same vendor you use to supply your employees with retirement plans. You’ll be looking at one of two types of plans: individual retirement accounts (IRAs) or 401(k)s. The IRS sets annual contribution limits on all types of retirement plans.
IRA-based retirement plans for small business owners
Despite the word “individual” in the name, small business owners may offer IRAs to the whole team – including themselves. Below are three types of IRA-based small business owner retirement plans.
1. Traditional payroll deduction IRA
Typically, with a traditional payroll deduction IRA, your employees will set up a traditional or Roth IRA with your retirement plan vendor. Once they do that, they may set an amount to funnel from each of their paychecks to their IRA. Your business will generally automatically send this amount of money to the employee’s IRA when you process your payroll. For 2022, the employee IRA contribution limit is $6,000. This limit generally increases to $7,000 for people age 50 and older.
A payroll deduction IRA is a low-cost option with no IRS paperwork requirements. It’s typically an even lower-cost option if you make matching contributions for every dollar the employee adds – these contributions may qualify you for tax credits. However, payroll deduction IRAs aren’t tax-deductible, and their contribution limits are typically the lowest of all retirement plan options.
2. SEP-IRA
A SEP-IRA (Simplified Employee Pension IRA) is an option whether you’re a sole proprietor or you have many employees. Employer contributions comprise most of a SEP-IRA’s funding, though employees may sometimes contribute up to the federal IRA limit as well. Direct employee IRA contributions cannot be paycheck deductions.
You may contribute at most 25 percent of an employee’s annual earnings to their SEP-IRA account, with a maximum of $61,000 for 2022. If you’re self-employed and your SEP-IRA only covers you, you may generally contribute, at most, 20 percent of your income.
SEP-IRA contribution limits are typically much higher than with traditional payroll deduction IRAs, and your employees will likely look upon that more favorably. However, you must contribute the exact same amount to all employee accounts, and your contributions aren’t tax-deductible. That said, there are no other annual contribution requirements, so SEP-IRAs may be a great option for cash flow management.
3. SIMPLE IRA
With a SIMPLE IRA (Savings Incentive Match Plan for Employees IRA), you and your employees are able to make tax-deferred retirement contributions. This generally means you won’t pay taxes on your contributions until after you withdraw them. Any business with at most 100 employees, including sole proprietors, may open a SIMPLE IRA as long as it’s their only retirement plan offering.
Employees may contribute up to $14,000 to their SIMPLE IRAs in 2022. This limit increased to $17,000 for employees age 50 or older. There are generally two possible employer contribution structures for a SIMPLE IRA.
- You may match employee contributions dollar-for-dollar until you reach three percent of the employee's annual salary. You may lower this figure to one percent during any two years of a five-year period.
- You may contribute two percent of each employee’s salary. The maximum salary for this contribution is $305,000 for 2022. This means that if your employee’s salary is $305,001 or greater, your maximum contribution is still two percent of $305,000, not $305,001.
A major advantage of SIMPLE IRAs is that they typically incentivize your employees (including yourself) to contribute more. That’s because, generally, the more they contribute, the more your business contributes – and that’s basically free money for them. That said, this model tethers you to certain payment amounts, and the contribution limits are often low compared to SEP-IRAs. But you may also implement a SIMPLE IRA without discrimination testing, saving you time and hassle.
401(k)-based retirement plans for small businesses owners
401(k)s are another type of retirement plan. They mostly differ from IRAs in name – the two plan types’ contribution structures and rules often overlap significantly. Below are three prominent types of 401(k)-based retirement plans.
1. Solo 401(k)
A solo 401(k), also known as an individual 401(k), is a retirement plan your business may sponsor if you’re self-employed with no employees. You may also set up a solo 401(k) if you’re a partner in a business whose employees are only the partners and their spouses.
With a solo 401(k), your business may contribute up to $61,000 in 2022. Employees are able to also contribute up to $20,500 in 2022, or up to $27,000 if ages 50 and older. An exception exists if you’re self-employed. In that case, your contribution maximum depends on a complicated calculation since you’re both employer and employee. A tax advisor or accountant can help you with this, or you can use the IRS’s solo 401(k) contribution limit calculator.
Solo 401(k)s are advantageous because your business’s contributions are typically tax-deductible. You can also choose not to contribute to solo 401(k)s during certain years. However, when you do contribute, each person with a solo 401(k) account through your retirement plan must receive the same percentage.
2. Traditional 401(k)
Within most employer-sponsored 401(k) plans, you have the option to offer yourself and your staff traditional or Roth 401(k)s. You and your employees won’t pay taxes on any money you deposit into your traditional 401(k) accounts. Instead, you’ll pay federal income taxes (and state and local taxes, if applicable) when you withdraw money. If you withdraw from your account before you reach age 59½, you’ll also pay a ten percent penalty. The contribution limit is $20,500 for 2022.
Traditional 401(k)s may be advantageous if you or your employees expect tax rates to decrease in the long run. They may also more clearly show how much income has been deferred to a retirement account. The total value you’ll see as invested in your traditional 401(k) is 100% of your salary deferral rather than a post-tax figure. Of course, this amount is deceptive – your actual amount saved will be much lower post-tax. And if tax rates increase in the long run, you’ll typically pay more on your retirement funds.
3. Roth 401(k)
A Roth 401(k) is basically the inverse of a traditional 401(k). You and your team will pay taxes on your deposits now rather than later. That means you won’t pay taxes on your retirement savings when you withdraw them. The ten percent penalty for withdrawal before age 59½ still applies. For Roth 401(k)s, the 2022 contribution limit is also $20,500.
If you expect tax rates to be lower now than when you’re retired, a Roth 401(k) may be a safer bet. The amount in your retirement account is also exactly how much you’ll have available during retirement – you’ll have no additional taxes to pay. However, if tax rates decrease in the long run, you may regret choosing a Roth 401(k).
How small business owners can plan for retirement
There are extra considerations beyond IRAs and 401(k)s that apply to small business owner retirement planning. Below are some additional steps small business owners should consider taking to plan for retirement.
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Decide how you want to live during retirement
It’s one thing to retire and spend your days mostly at or around your home relaxing. It’s another to envision your retirement as a period full of stunning destinations and lavish experiences. If you’re anticipating a quiet retirement, you may save the expert-recommended 15 percent of your income for retirement. If you’re looking for something more adventurous, you may need to increase this figure.
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Align your retirement plan options with your percentage of income saved
The more of your income you plan to save for retirement, the less realistic it is to invest in low-limit retirement plans. Instead, you may want to consider options with higher limits, such as SEP-IRAs or SIMPLE IRAs. As you make your choice, consider how employer-matching requirements might increase the amount your business spends to maintain your retirement plan.
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Prepare a business exit strategy
When you own a business, you typically can’t go into retirement without formally relieving yourself of your responsibilities. Business exit strategies are often the easiest way to navigate this tricky process. You have three options on this front: initial public offerings (IPOs), management buyouts (MBOs), and strategic acquisitions. Your goal with each is to sell your shares in your business, both yielding you a profit and allowing you to fully step away.
With an IPO, you’ll take your business public and sell stocks on the market. With an MBO, your corporate management team will buy out your shares. With a strategic acquisition, another company will entirely take over your business. This is similar to a business merger, with the additional goal of minimizing or entirely eliminating your involvement.
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Conduct a business valuation
As you prepare to sell your stake in your business, you’ll need to know how much your company is worth. This typically means bringing in a professional to appraise your business and its assets and investments. (Separately, you should consider reviewing your personal assets and investments.) Your appraisal will typically determine the amount for which you can realistically sell stocks, shares, or your whole business. This figure may add to your retirement savings.
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Only dip into your retirement savings once you’re fully retired
Technically, you can start withdrawing from your retirement savings with no penalty once you turn 59½ years old. But no matter when you retire, your retirement account’s value will typically increase the longer you leave it untouched. That’s because retirement accounts are investment accounts, meaning your money is stored in assets that often gain value over time. This means you should generally only dip into your retirement savings once you actually stop working.
Choosing the right retirement plan for you and your business
You may be able to easily save for your own retirement while offering IRAs or 401(k)s to your whole team. Some factors to consider as you choose a vendor and retirement plan type include contribution limits, employer-matching requirements, ease of use and management, and costs. The latter factor is an especially big one – after all, labor can comprise up to 70 percent of your expenses. Paying for your employees’ retirement plans generally only adds to that cost.
With SmartBiz®, you can apply for working capital loans that can help you cover all your labor costs, including your payroll and employee benefits. It takes just five minutes to see whether you pre-qualify for SBA loans, which are experts’ top pick for small business funding. And if you don’t, you can also pursue excellent bank loan and custom financing options. Check now whether you pre-qualify* for funding that may benefit you and your whole team.
