Owning a business can be extremely rewarding- creating your own schedule (no clock in/out), being your own boss, and running the show. It can also have its own challenges, and with so many moving pieces it can be easy to forget things- like planning for retirement.
In fact, according to a survey, one-third of small business owners lack a retirement savings plan. When asked why, respondents stated reasons such as lack of profit, no plans to retire, and using their retirement savings to start the business (Source: PRNewsletter).
It can be easy to forget how important a retirement plan is when running a business, but know that you have options. Starting to think about your future now is the best way you can invest in yourself.
How Do I Choose a Retirement Account?
One of the most frequently asked questions by those who are self-employed/small business owners is:
How do I choose a retirement account?
This question depends on the individual and what their situation and goals are, and will differ for everyone. The good thing is, you have quite a few different options (which we will break down below).
One option is a SEP-IRA. which stands for Simplified Employee Pension. This type of retirement account must be set up by an employer (or self-employed) and can also be set up for your employees. This option is good for small business owners with minimal employees.
The annual contribution limit for this plan is up to 25% of total income or $61,000 for 2022 (lesser of the two). Another benefit to this retirement plan is that contributions are tax-deductible and earnings are tax-deferred, which can mean a big tax break for employers. One thing to note, this plan requires you to make the same contribution percentage to each employer enrolled in the plan. This means you cannot contribute 10% to one employee and 5% to another.
Pros: Tax Advantages, early withdrawals, ease of setup/maintenance
Cons: No catch-up contributions, no option to take a loan/borrow against the balance.
401(k) & IRA
Small business owners and those who are self-employed still have access to two popular options, the 401(k) and IRA.
Many individuals seem to think that 401(k) accounts are only offered by large companies, but this is not true. If your small business consists of just you (and possibly your spouse), you can open up a Solo 401(k). This account has a unique advantage, which allows you to contribute as both the employer and the employee. The total contribution limit (for both employer and employee contributions) is $61,000 for 2022.
Pros: High contribution limit, can make Roth (after-tax) contributions, tax deductions.
Cons: Must make consistent contributions, cannot have employees.
If you do have employees working for your small business, another great option is a Simple 401(k). This account is only available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer in the prior calendar year. This account is a simplified version of the traditional 401(k) offered by employers, and can be a cost-effective way to provide employees with retirement plans. It is also not subject to the same annual nondiscrimination tests that apply to traditional 401(k) plans.
Pros: Tax deferral, fully vested, ability to take loans.
Cons: Must have under 100 employees, employer contribution mandatory.
Another option is the traditional IRA account. This is a simple way to invest in your own retirement as it is easy to set up and start contributing right away. It takes just minutes to set up with a brokerage and has minimal fees. These contributions are tax-deferred, meaning you will not pay taxes until you start taking distributions. You can also choose to open a Roth IRA in which you pay taxes now and enjoy tax-free distributions during retirement.
Pros: Tax-deferred, easy to set up.
Cons: Income limitations, lower contribution limits.
Defined Benefit Plan
A less commonly used retirement option is a Defined Benefit Plan. This type of retirement account is set up by the employer and provides a fixed benefit for employees when they reach retirement. This type of retirement plan can be used in addition to other plans and allows both the employer and employee to contribute. A benefit to this option is it provides predictability to the individual and there are no “guessing games” on how much they will receive in retirement. A few downsides include the expenses, administrative work, and certain taxes that can occur.
Pros: Higher contributions compared to other plans, predictable benefits, not dependent upon returns.
Cons: Excise taxes, maintenance costs, administrative upkeep.
Other Things to Consider
Great work! You have determined what plan is right for you (if not, we recommend speaking to a financial professional for guidance), but now what?
After you have taken the first step towards your retirement (researching and choosing a plan), there are a few other things you may want to take into consideration as a small business owner…
1. What do you want your retirement to look like?
Although you may be years (or decades) away from retirement, you should still consider what your long-term goals are. Do you want to travel the world, start a new business, or maybe just relax on the beach? Answering these questions will be the start to forming your retirement plan as you need an idea of the type of lifestyle you need to finance.
Estimate your needed retirement income by determining how much you can comfortably live off of (and add some cushion). Don’t forget about inflation either- things will likely be more expensive by the time you retire. You can use an online calculator such as this one to find your needed annual income.
2. Will you continue to run your business?
Another big question- what will happen to your business after you retire; will you continue to run it, sell it to a stranger, or pass it down to your children/grandchildren? This will also be a consideration when calculating your income and savings needed for retirement.
If you continue to run it, you may choose to scale back to part-time or hire a helper so you can relax and travel more. If you sell the business, you may be able to use that money to live off of for retirement (although, it is still suggested you start saving well before then, just in case).
3. What about insurance?
This one often gets overlooked– health insurance. If you do not plan to retire until age 65 or older, you can take advantage of medicare. If you want to retire sooner than that, you should start considering how you will cover the cost of health care.
“U.S. households led by someone who is 65 or older spend an average of $7,030 a year on health care, according to the federal Bureau of Labor Statistics’ latest data on consumer spending, which is for 2021.” (Karla Bowsher, MoneyTalksNews)
This means, you do not want to forget to add a line item to your budget for health care costs, or it can add up quickly. If you are under age 65, those who are self-employed or own a small business will likely need to purchase their health insurance through the marketplace (and it can be pricey).
4. What if I need help planning for retirement?
If you have read this far and you are still scratching your head, no need to worry.
There are plenty of financial professionals who can help you to meet your goals, without any judgment. At Artesys, we help individuals from all walks of life to make a financial plan and start their investing journey. Reach out today for a consultation.