Small business owners, especially those with a service-based business, have many things to concern themselves with each day. One such item of concern is retirement for themselves and their employees. However, it can be a bit daunting to decide which retirement option to select, and if you should even offer a plan to your employees.
Recently, there have been more retirement planning options for small business owners that they can take advantage of. This includes employer-sponsored plans for businesses with 2 to 100 workers as well as plans that are designed for self-employed individuals.
Utilizing the tax advantages available to small businesses, owners can open different types of retirement accounts, including IRAs. Let’s discuss the choices that small business owners have for retirement planning.
Widely known as a wise choice, the traditional Individual Retirement Account (IRA) is a great choice if you have decided not to provide a retirement plan for your employees. It is also a smart option if you are self-employed and need to save for your own retirement. While there are no income limits to a traditional IRA, there are limits as to when the contributions are considered tax deductible. For 2023, the phase-out range for single taxpayers covered by a retirement plan is between $73,000 and $83,000.
The advantages of having an IRA as a small business owner, especially a service-based business, are that almost anyone is eligible to participate and there are typically no costs to setting it up.
Individual and Traditional 401(k)s
A retirement account that can be used by self-employed people and their spouses is an individual 401(k), also known as a one-participant or solo 401(k). This type of retirement plan is not eligible to small business owners who have employees. It is an excellent option for those who want to maximize their retirement contributions. You can contribute to this account as both the employee and the employer.
While choosing retirement planning options for small business owners, an individual 401(k) requires a little more paperwork than other retirement accounts. However, it allows higher contributions – 20% of net self-employment income.
The traditional 401(k) is possibly the most popular type of retirement plan for service-based businesses with employees. This alternative allows employees to contribute a higher dollar amount to their retirement savings. Employee participation is optional and grants them the opportunity to make pre-tax contributions and take out loans from their retirement savings. For small business owners, the traditional 401(k) may be costlier and more complex to set up than other retirement plans.
The Savings Incentive Match Plan for Employees, also known as the SIMPLE IRA, is a retirement account option for small business owners who have less than 100 employees. Through salary deferrals, employees can contribute up to $15,500 to this account in 2023, with a catch-up contribution of $3,500 for persons aged 50 years or older.
Moreover, self-employed individuals who choose this plan can contribute to it as both the employee and the employer. Employers must either match 3% of employee contributions or contribute 2% to all of their employee accounts.
While considering retirement planning options for small business owners, an important factor to note with the SIMPLE IRA, is that while your obligation as an employer is less, the contributions that you are able to make for yourself are also significantly lower than other retirement plans. This is due to the fact that the business owner is subject to the same limits as employees. Plus, the SIMPLE IRa plan does not allow specific features like other plans, such as loans and Roth contributions.
A Simplified Employee Pension (SEP) IRA is a good choice for small business owners, especially service-based businesses, to offer to their employees. These retirement accounts are funded by employer contributions only, so there are no employee salary deferrals involved. It is an ideal retirement savings plan for employers regardless of their business structure – even sole proprietors – due to its flexibility and ease of maintenance.
Generally, it allows for larger contributions, minimal paperwork, and more flexibility. Employer contributions are not required annually, which means that business owners can contribute only during higher profit years, if they would prefer to do so. According to the IRS, the contributions that you make to each of your employees’ SEP-IRA in 2023 cannot exceed the lesser of:
- 25% of compensation, or
Using a SEP IRA, small business owners are required to contribute the same percentage of an employee’s compensation as they would contribute for themselves – potentially including part-time workers. This could amount to a large sum if you have a few employees.
There are several retirement planning options for small business owners. It is always recommended to consult with a tax advisor or accountant to determine which retirement account would be best to employ in your business.
If you are in a competitive field and would like to attract the best employees, you may consider offering a retirement plan, such as a traditional 401(k) or SEP IRA, for your service-based business. However, it is crucial to remember that employers are not required to offer retirement benefits to their employees. If you choose not to do so, it is equally important that you save for your own retirement.
Plans such as the traditional IRA or individual 401(k) are perfect for retirement savings for self-employed people. Regardless of the option that you choose, planning for retirement savings should always be paramount.
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