Top 5 Retirement Plans for Small Business Owners

Owning and building your business is an exciting, hopefully profitable, adventure. You use your hard work and entrepreneurial spirit to accumulate enough wealth to live well now and retire early with no financial worries.

But many small business owners are too busy working and growing their businesses. They keep putting off setting up any type of retirement plan for themselves or their employees.

More than 34% of small business owners have NO retirement savings plans. And 40% don’t believe they will be able to retire before age 65. With no retirement plan in place, they are probably right. 

Why Don't Business Owners Set Up Retirement Plans?

Many owners say they don’t have the money to set up a retirement plan. About 20% say they will fund their retirement by selling their business. And 12% say they plan on never retiring, with another 12% believing that retirement plans are not necessary.

And what about your employees? More than 70% of small businesses with less than ten employees don’t offer any retirement plans. Only about 50% of companies with 10 to 24 employees offer any type of retirement plan at all.

Small business owners state that setting up plans for their employees is too expensive, too complicated, and has burdensome administrative costs. Surprisingly, half of small business owners believe their employees are not interested in retirement plans.

Retirement Plans Attract and Help Keep Quality Employees

Almost everyone worries about retirement, especially employees. More than half the employees who left a small business state one primary reason was no retirement plan. For those businesses with 401ks, half said they use retirement plans as a major recruiting tool. If you want to attract quality employees and keep them, you should offer them a retirement plan. You will increase employee productivity, retention, and acquisition.

The IRS Wants to Help You Save for Retirement

While many small business owners do not think of the IRS positively, they are trying to help you save for the future when it comes to retirement plans. Numerous tax advantages can help your retirement account grow untaxed until later, which allows compound interest to work for you faster. Also small business owners should keep in mind that many employer contributions are tax-deductible and plans can be easy to set up and maintain.

While there are many plans out there, below are the Top 5 Retirement Plans for Small Business Owners:

1. Solo 401(k): Maximizing Contributions and No Employees

This is an excellent plan for a business owner or self-employed person with no employees, except for a spouse.

 For 2021, the contribution limit is $58,000, and for 2022 the limit is $61,000, plus a $6,500 catch-up contribution or 100% of earned income, whichever is less. 

As an employee, you can contribute similarly to the standard employer-offered 401(k), with salary deferrals of up to 100% of your compensation. This is $19,500 in 2021, $20,500 in 2022 (plus that $6,000 catch-up contribution, if eligible), whichever is less.

However, as the employer, you can make an additional contribution of up to 25% of compensation.

There is a special rule for single-member LLCs and sole proprietors. You are allowed to contribute up to 25% of net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself.

The compensation limiting factor for your contribution is $290,000 in 2021 and $305,000 in 2022.

The Solo 401(k) is similar to a standard, employer-offered 401(k). You make pre-tax contributions, and then distributions after age 59½ are taxed.

You cannot contribute to a solo 401(k) if you have employees. But you can hire your spouse, and they can also contribute to the plan. Your spouse can contribute up to the standard employee 401(k) contribution limit, plus you can add in the employer contributions for up to an additional $58,000 total in 2021 or $61,000 total in 2022, plus catch-up contribution, if eligible. This potentially doubles what you can save as a couple.

This plan is ideal for business owners with good years and bad years. You can contribute a great deal during good years and less in the not-so-good years. Keep in mind the contributions limit is per person, not per plan, so if you also have outside employment that offers a 401(k), or your spouse does, the contribution limits cover both plans.

2. SEP IRA: Easy Administration and Few to No Employees

This plan is often used by self-employed people or small-business owners with few or no employees. The SEP IRA is flexible, like the solo 401(k), and you do not have to contribute every year.With the SEP IRA, your contribution is limited in 2022 to the lesser of $61,000 ($58,000 in 2021) or up to 25% of compensation or net self-employment earnings (approximately 20% of your profit). There is a $305,000 ($290,000 in 2021) limit on compensation that can be used to factor in the contribution. But there are no catch-up contributions.

The tax advantage is that you can deduct the lesser of your contributions or 25% of net self-employment earnings or compensation on your tax return. However, there is a $305,000 cap per employee in 2022. Distributions in retirement are taxed as income. 

As the employer, you must contribute an equal percentage of salary for each eligible employee. Remember you are counted as an employee so if you decide to contribute 10% of your compensation for yourself, you must contribute 10% of each eligible employee’s compensation.

The advantage is this plan is easy to set up and easy to administer, with no annual reporting to the IRS. The downside is whatever percentage you contribute for yourself, you must do the same for the employees. Often, this is used by a high-earning, self-employed person with no employees.

Another neat thing about SEPs is that you can actually contribute for a previous year in the next year until you file your tax returns. For example, you can contribute to your 2022 SEP up until you file your 2022 tax returns, which is usually between February and April 2023!

3. SIMPLE IRA: Employee Participation and Up To 100 Employees

The Simple IRA Plan is often used for larger businesses with up to 100 employees.

The contribution limit in 2022 is $14,000, ($13,500 in 2021) plus the catch-up contribution of $3,000 for 50 years or older.). If you are also contributing to an employer plan, the total of all your contributions can’t exceed $20,500 in 2022 or $19,500 in 2021.

Contributions are deductible, and distributions in retirement are taxed. But, as an advantage to the small business employer, contributions made to employee accounts are deductible as a business expense.

This plan differs from the SEP IRA. Here, the contribution burden isn’t just on you: Employees can contribute and do so through salary deferral. 

As the employer, you must contribute and can do so in one of two ways. You can match contributions up to 3 percent of the salary or, you can contribute up to 2 percent of a worker’s salary up to the annual compensation limit of $305,000 in 2022.

Also, employees become fully vested as soon as they receive the funds, so any contribution you make becomes theirs immediately. The contribution compensation limit for factor is $305,000 in 2022 ($290,000 in 2021).

If you own a midsize company with fewer than 100 employees, this may be a good option for you. It is easy to set up, and the employees own their accounts. One downside is that it can be expensive if you have many employees participating.

4. SIMPLE 401(k) Less Administration than Standard 401(k)

This is an alternative for companies that want to avoid the administrative burden of a standard 401(k) and have less than 100 employees.

Employees can choose to contribute, but unlike a regular (401(k), the employer is obligated to make a matching contribution of up to 3% of each employee’s salary or a non-elective contribution of 2% of each employee’s salary. 

The administrative burden for the company is lower because they are not required to perform expensive non-discrimination testing as it would with a regular 401(k). 

5. Traditional or Roth IRA: When You Are Just Starting Out

The Traditional or Roth IRA is often best when just starting out in business. For example, if you leave your job to start a business, you can also roll your old 401(k) into an IRA. IRA contribution limits are $6,000 in 2021 and 2022 ($7,000 if age 50 or older).

You get a tax deduction on contributions to a traditional IRA. However, while there is no immediate deduction for Roth IRA, the withdrawals in retirement are tax-free. This is a significant difference.

These are individual plans, and you do not set them up for your employees. However, they can set up and contribute to their own IRAs.

An IRA may be the easiest way for self-employed and small business owners to start saving for retirement. 

Whether or not you have employees, you can use it and there are no special filing requirements, but you must decide between a traditional or Roth IRA.

The major differences are:

Roth IRA

  • No immediate tax benefit for contributing.
  • Contributions can be withdrawn at any time without taxes or penalties.
  • Ability to contribute is phased out at higher incomes.
  • Qualified withdrawals in retirement are tax-free.

Traditional IRA

  • If deductible, contributions reduce taxable income in the year they are made.
  • Deductions can be phased out depending on income.
  • Distributions in retirement are taxed as ordinary income.
  • At age 72, there are required minimum distributions.

If you expect to be in a higher tax bracket in retirement, you might choose a Roth IRA for its delayed tax benefit. If you believe you might have lower rates in retirement, choose a traditional IRA with its upfront tax advantage.

Choosing Your Retirement Plan – Your Next Best Steps

A retirement plan will help you attract and keep qualified employees and they will be more productive and fulfilled in their work.

But even if you are a self-employed, one-person business, the reason you started your business was to financial freedom – and a good retirement plan can help you get there faster.

Surprisingly the IRS is trying to help you with tax advantages, tax credits and tax deductions.

So, the question is not IF you should have a retirement plan.

The real question is which plan can best help you achieve your goals.

Let us help.

While the plans may seem confusing to you at first, this is all we do.

It is almost impossible for anyone to keep up with all the retirement plans and their changes – and you don’t have 

Your time is best spent growing your business.

We keep up with all the rest for you.

​​ At CE Accounting, we don’t just file forms and crunch numbers. We analyze your business and your business goals to minimize your tax obligations and the right retirement plan is a big part in achieving your goals.

Call today and let us show you the next best steps for choosing the best retirement plan for your small business.

“This article is not intended to give, and should not be relied upon for, legal tax advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of a qualified professional.”