What is the best retirement plan for a self-employed person? Which is the best retirement plan for a small business owner? More importantly, which is the right retirement plan for you – as a business owner and / or a self-employed individual? Choosing the best retirement plan for you and your personal financial goals will depend on a few factors. Those include how much you can save into a retirement plan, whether or not you have employees and when you are setting up the retirement plan. Is it during the tax year or when filing taxes? To name a few.
As a small business owner, you are likely busy running your business and haven’t had the time to research the best retirement plan for your firm. I would challenge you to remember that a penny saved is a penny earned, and a retirement plan can help you keep more of your hard-earned money. Take the time to plan for your future, and lower your current tax liabilities.
Even if you plan to never retire, because you love what you do, it’s still nice to achieve financial freedom and have the choice to not work anymore. At the very least, look at saving for retirement as a way to pay less in taxes.
Ideally, you will be saving in the range of 10-20% of your gross income each and every year. If you are getting a late start, you may need to save even more. That may seem impossible, but I assure you, it’s not. If you’re unable to save 10-20%, start saving a smaller percentage of your gross income. You can then work your way up to saving more. The important thing is to start saving something. Consider the following retirement options depending on what type of saver you are.
The Small Saver – Up to $6000
IRA contribution limits have increased to $6,000 for 2019. If you are expecting to save no more than this amount in 2019, consider a Traditional IRA or a ROTH IRA. An additional $1,000 catch-up contribution is available for those who are 50 and older making the total allowable contribution $7,000.
The Medium Saver – $6,000 to $55,000
For those looking to save more than $6,000, per year, you will need to move beyond only using a Traditional IRA or ROTH IRA. Consider adding a Solo 401(k) or Simplified Employee Pension (SEP) IRA to the mix. These small business retirement plans have higher contributions limits. Bigger contributions translate into larger tax deductions.
Both plans come with a maximum contribution limit of $55,000 for 2019. The allowed contribution amount will vary from business owner to business owner. Likewise, what you can contribute will vary between the SEP IRA and Solo 401(k) plan.
SEP IRA: This type of retirement account is more common as it has been the easier of the two accounts to set up and maintain. However, you will likely be unable to contribute as much money to a SEP IRA compared to a Solo 401(k). Generally speaking, you can contribute up to 25% of your adjusted gross income (after other tax deductions, which will include your SEP IRA contributions).
SEP IRA is great for Procrastinators: I am writing during tax season 2019. This is when you will likely be filing your 2018 taxes. One big advantage of the SEP IRA is that you can still set it up and fund it for the prior tax year.
For example, let’s say you get surprised with a huge tax bill. You could potentially make a large SEP IRA contribution to minimize the tax hit. You have until you file your taxes to make the full contribution, meaning you could potentially wait until October to set up and fund this type of retirement account. A solo 401(k) plan needs to be set up before the end of the tax year. However, you would still have until filing taxes to make the profit-sharing portion of your contribution.
Solo 401(k): Solo 401(k) plans have grown in popularity over the last few years. They have become much easier to set up and maintain. Additionally, the costs and fees associated with these plans have decreased.
When using a Solo 401(k) (you can also set up a Solo Roth 401(k)), you will have an easier time putting more money away in a tax-preferred manner. For 2019, you can sock away $19,000 as an employee of the business or up to 100% of your income. That, plus profit-sharing contributions (made by the business), means a whopping $55,000 can be put into this type of plan, per person, per year. Allowable profit-sharing contributions will be based on your net income, or payroll, and are similar to the SEP IRA calculation.
Additionally, those who are 50-years-old, or older, can make catch-up contributions up to $6,000, per year to a Solo 401(k). That brings the potential maximum contribution to $61,000, per year. SEP IRAs do not allow catch-up contributions.
Maximum Savers – $55,000 and more
Are you a large saver or just running a super-successful business and making great profits? If you need to save more than $55,000, per year, you may want to consider adding a Defined Benefit Pension Plan to your 401(k) / profit sharing plan. You get the benefits of a Solo 401(k) and get to stack the larger contribution limits of a pension plan on top of that. You may also hear these plans called the Rich Person Pension or a Cash Balance Pension Plan.
These plans are less common in part because not many people are willing or able to put away $55,000 or more, per year, for retirement. They are structured for high earners who own and operate small businesses or are self-employed. Business owners with a few employees, and those who work alone, will receive the most benefit. Specifically, individuals who are in the age range of late forties and retirement will receive the maximum benefit.
Again, this is a plan to consider once you are already maxing out your 401(k) / profit sharing plan. These plans do come with minimum funding requirements so you need to be prepared to make substantial contribution for several years. You will get a tax deduction for your contributions, but distributions will be taxed when made in the future. You are essentially setting up your own personal pension, which you can later turn into a guaranteed income stream for the rest of your life. This is similar to the pension your parents, or grandparents, likely enjoyed during their golden years.
Lastly, these plans are often more complicated to set up and run. Consult with a certified financial planner, and fiduciary, who has the knowledge and expertise in setting up these types of plans properly.
Personal Defined Benefit Plan or Cash Balance Pension Plan: How much can you contribute to these pension plans? Your maximum allowable contributions, per year, will be based on your age and income. Basically, the older you are the more you will likely be able to contribute. It is not uncommon to be able to contribute $300,000, or more, into a combination of pension and 401(k). Think of all the money you could save if you were able to lower your current taxable income by $300,000 or more. The downside here is pension plans are often costly to set up and run. Of course, those costs are also tax deductible. You will also need to make contributions for employees who meet certain requirements, such as hours or time working for you.
As your income grows, the best combination of small business retirement accounts for you may also change. You may feel overwhelmed from running your business, and thinking about retirement is the last thing you want to do. Make the time if for no other reasons than the potential for huge tax savings and that saving for retirement may lead to the financial freedom to work less in the future.
Closing note: There are other factors to consider when choosing the best retirement accounts for your business. Consult your fiduciary financial planner and tax professional to help determine which retirement account(s)? will allow the largest contributions for you. Also, talk with your CFP® to pinpoint how much you actually need to be saving in order to maintain your current standard of living in retirement and achieve financial freedom.