Insights into the world of small business lending and development

Navigating small business retirement options

When you work for a large company, decisions about saving for retirement are often made for you—your employer likely offers some sort of savings account that provides tax benefits for you to save for retirement, and may even match any contributions you put into that account. But when you’re a small business owner, you have to navigate the retirement savings process alone, which can be stressful. It may seem even trickier if you have employees and need to set up a plan by yourself. But there is a lot of good news:

  1. You have MORE options than does the average large corporation.
  2. There are options specifically geared to small businesses.
  3. If you are willing to do a little of the work yourself, many of these options are free.
  4. Best of all, you get tax deductions!

Unlike in decades past when pensions guaranteed you some level of income from your employer even in retirement, most people today use a defined contribution plan to save for the future. For small businesses, there are two main types of defined contribution plans. The first is one in which you, the employer, make all the contributions on behalf of yourself and your employees (if you have them). The second type is where your employees contribute for themselves too. All plans feature tax benefits, but before diving into the different tax benefits, it’s important to know what the different plan options are. For small businesses, the two most common plans are 401(k) plans and Simplified Employee Pension Plans (SEP IRAs):

  • 401(k): A 401(k) is a type of employer-sponsored retirement plan that allows employees to put a portion of their paycheck into a retirement savings account. Often, employers will also make contributions to the employee’s 401(k) and the plans are portable, so when an employee moves jobs, their 401(k) will go with them.

    One advantage of 401(k) plans is that they allow employee contributions of a relatively large amount annually—$19,000 per year for those under 50, and $25,000 for those 50 and older. However, 401(k)s can be costly and administratively difficult for a small business to establish. Usually you would need to hire a service provider to help you with the plan, like a third party administrator or benefit consulting firm.

    There is a special type of 401(k) just for the self-employed—as long as you have no employees who meet the plan age and service requirements. Called an Individual or “Solo” 401(k), this plan is easier to run than a traditional multi-employee 401(k), and it allows the self-employed to contribute up to the 401(k) maximum of $56,000 (or $62,000 for those age 50 or older). As the self-employed business owner you can decide if part of that $56,000 is made as a Roth deferral or pre-tax deferral. With this much flexibility it does take a bit of effort to track different aspects of this plan, but it is an option that generally allows the highest contributions for business owners.

  • SEP IRAs: Unlike a 401(k), SEP IRAs are available to any size business and work especially well for both the self-employed and for those with employees. SEP IRAs are usually easier to manage than 401(k)s, but they cannot allow any contributions from employees—all the contributions come from your business. Contributions are fully tax deductible to you and can be quite high: $56,000 (up to 25% of each employees’ compensation). These contribution limits also apply to the self-employed, so they may be a good option if you’re a solo entrepreneur with significant profits you’d like to save for retirement. SEPs also don’t require you to contribute every year, and—like it says in their name—are simple to set up and maintain.

    If you have employees and they are at least age 21 and have worked for you at least three out of the preceding five years, then they must be covered in your plan and receive contributions. Working for you any part of a year (even one hour during the year) counts as a year of service, so they aren’t good options if you have a lot of part-time employees that you do not want to cover in your plan.

While you’re probably most familiar with the corporate 401(k)s or even personal IRAs, there are several other options available for small businesses, including the Solo 401(k) and SEP IRA discussed above. As you consider all your plan options, it’s important to compare and contrast features of the plans. Check out the table below for some key features and questions you want to review.

Features for Comparison

Employer Eligibility

Can any size business offer the plan or is there a maximum business size?

Age Restriction

Do you want to exclude employees who are under age 21 or a lower age?

Service Restriction

Which employees must be included in the plan and which do you want to include? Can the plan only include employees with the business for a defined period of time? (e.g., one year, 1,000 hours; etc.)

Annual Notifications/Reporting

Does the small business employer need to file any special forms with the IRS and are there any required notices to employees on the plan?

Funding Options

Are employer contributions required or optional?

Do you want employees to contribute for themselves? If so, are employee deferrals pre-tax, or Roth?

Maximum Contribution

What is the total amount the employer can contribute to the plan?  

If employee contributions are allowed, what is the maximum employee deferral amount per year, and what is the age 50 “catch-up” amount?

Special Features

How simple and convenient is plan maintenance? Who will handle each of the responsibilities?

What are the administrative fees and who pays them?

Withdrawal Restrictions

Can a participant withdraw contributed funds at any time or only upon death, disability, separation of service, or plan termination?

Are plan loans available and do you want to offer that feature?

 

It’s also important to know that many of the types of accounts lower your taxes today by allowing you to make contributions into your retirement account before you’ve paid income taxes. This lowers your taxable income, so you may pay less in taxes now. However, when you withdraw from the account in retirement, that money is part of your taxable income. Other plans like Roth IRAs (and Roth contributions made into 401(k) plans) do not offer any tax savings today, but allow you to withdraw contributions and their earnings tax-free in retirement. 

Regardless of which plan you choose, you could be eligible for IRS tax credits specifically designed for small businesses that establish a retirement plan. Generally, a credit of $500 is available each year for over three years to cover plan startup costs.  

If you want to learn more about retirement options for small business owners, the next step for many is to find a vendor—usually a financial services firm. There are numerous options you can explore online, including TD Ameritrade. TD Ameritrade focuses on do-it-yourself small business plan options, shown here.     

Other tools and resources to help you understand your options include a Small Business Retirement Contribution modeling tool. This tool allows you to model different contribution levels in various plan types and it can help you determine which of your employees should be included in your plan.

In addition, the Retirement Calculator can help you decide how much you need to save for retirement, to make sure you are creating a secure retirement future today

 

 

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