What retirement plan is best for my small business?

Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®
Entrepreneurs love to steer the financial helm of their enterprises, primarily focusing on growth and profitability.
However, if you’re a business owner, it’s equally important to consider retirement planning.
Retirement planning forms an essential part of personal finance management, helping ensure a stable and worry-free financial future.
For business owners like yourself, though, this planning carries double the importance. You’re not only taking care of yourself but the financial future of your employees. And they trust you to do it right! Plus, properly implemented and utilized, retirement planning is an excellent tool to attract talent and retain high-performing employees.
Our goal in this article is to provide you with a clear understanding of the retirement plans available to you as a business owner, whether you are a sole entrepreneur, or the owner of a bustling business with many employees.

The Solo 401(K)

The Solo 401(k), also known as a One-Participant 401(k), is a retirement savings plan tailored for business owners with no full-time employees apart from themselves and their spouses.
One significant advantage of a Solo 401(k) is its generous contribution limits, thanks to the ability to contribute as both the employee and the employer. As of 2023, you can contribute up to $20,500 as an employee (or $27,000 if you’re 50 or older).
In addition, you can contribute an extra 25% of your ’employer’ compensation, creating a combined limit of $66,000 (or $73,500 for those 50 and above).
There are other perks, too, like the option to borrow against your savings, serving as an extra cushion during financial hardship.
You can classify your contributions as either:
a) Traditional pre-tax contributions, which defer your tax obligation until you withdraw your funds
or
b) Post-tax Roth contributions that give you tax-free income during retirement.
Unfortunately, the Solo 401(K) isn’t all fun and games – it also comes with administrative duties. For example, if your plan’s assets exceed $250,000, you must file an annual report on Form 5500-EZ. You’re also responsible for selecting your investment funds, deciding your asset allocation, and rebalancing your portfolio to stay on track with your goals – tasks that can be challenging without professional help. Of course, you can always partner with a Certified Financial Planner to help you out.

Simplified Employee Pension IRA

The Simplified Employee Pension (SEP) IRA is a retirement savings plan that benefits both employers and employees. It offers flexibility, simplicity, and higher contribution limits than traditional IRAs.

Key Perks:

Like the Solo, the SEP IRA comes with a high contribution limit. You can contribute up to 25% of an employee’s compensation or $66,000 (as of 2023), whichever is less. Unlike other retirement plans, you can set up and fund a SEP IRA until your tax filing deadline, giving you more time to collect all the information necessary to craft your tax strategy.
However, just like everything else in life, SEP IRAs have constraints. Only the employer makes contributions; when they hit the employee’s account, they are 100% theirs. This differs from a 401(K), where an employer can return matched funds if an employee leaves the company before vesting.
Plus, if you contribute for yourself, you must contribute the same percentage for all eligible employees. While attracting and keeping top-notch talent is a neat perk, it also means you’re committed to regular contributions.
One more thing: SEP IRAs don’t allow loans. You can’t tap into these funds before retirement without facing penalties and taxes.
A SEP IRA could be a fantastic choice for business owners with a small team or ups and downs in your profits. Its flexibility with annual contributions lets you adjust the contribution levels based on your business’s yearly profitability. This is a major employee bonus since the employer – that’s you – makes all the contributions.

Savings Incentive Match Plan for Employees IRA

The Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement plan tailor-made for small businesses, ideally with 100 or fewer employees.
Compared to traditional 401(k) plans, the SIMPLE IRA is easier to manage and kinder on the wallet, making it the potential go-to choice for your business.
Here’s how it works: in a SIMPLE IRA, employees contribute a portion of their pre-tax earnings to their retirement savings. On top of this, you, as the employer, must make either matching or non-elective contributions, essentially a percentage of an employee’s compensation.
As of 2023, an employee can contribute a maximum of $15,500, plus an additional $3,500 if they’re 50 or older. The employer can contribute a dollar-for-dollar match of up to 3% of an employee’s compensation or a flat 2% for each eligible employee (the non-elective contribution mentioned above).
Now, the main draw of a SIMPLE IRA is in the name – it’s simple! It’s straightforward to manage, and the administrative costs are on the lower side. Plus, you don’t have to worry about annual IRS testing or filing, making it less of a headache for small businesses.
Like always, there’s a catch – the contribution limit is lower than that of SEP IRAs or 401(k) plans. Lower limits could be a dealbreaker if you or your employees want to put away more for retirement. And a word of caution – the penalties for early withdrawals are pretty hefty, standing at 25% within the first two years of participation.

Profit Sharing Plan

This is a retirement plan that lets business owners distribute profits to employees in the form of retirement savings. Accordingly, your contributions are discretionary, meaning you can decide how much to contribute each year based on your business profits.
The key perk of a Profit Sharing Plan is its flexibility. You can choose the amount to contribute each year, which can be handy during leaner times. Plus, it can act as a motivating tool to retain your staff – who doesn’t want a share of the profits? It gives your employees an incentive to work harder and stick around longer.
All contributions you make are tax-deductible, while funds grow tax-deferred until retirement.
The maximum limit on contributions is the lesser of 25% of the employee’s compensation or $66,000 for 2023, similar to other plans we’ve discussed so far.
However, there are a few caveats with Profit Sharing Plans. They can be trickier and more expensive to manage than other retirement plans, and they require annual IRS testing to ensure they’re fair to all employees, not just the top earners.

Defined Benefit Plan

A Defined Benefit Plan, or as you might know it, a pension, is a retirement plan where you, as the employer, promise a specified monthly benefit on retirement. The benefit could be a fixed amount, like $1,000 per month at retirement, or it could be calculated based on an employee’s salary history, how long they’ve been with the company or other factors.
One of the main advantages of a Defined Benefit Plan is its predictability. Unlike other retirement plans where the benefit depends on investment returns, employees know exactly what they’ll get when they retire, drastically simplifying financial planning. These plans can help attract and retain staff by offering a stable and secure retirement benefit.
Regarding tax benefits, your contributions to Defined Benefit Plans are generally tax-deductible, cutting down your taxable income.
Conversely, Defined Benefit Plans come with their share of responsibilities. They’re generally more complex and costly to set up and maintain than other retirement plans. They need an actuary to determine funding levels, and any investment risks are all on you. And since you’re committed to paying a specific benefit, you need to ensure you have enough funds for future payments.
While many view a pension as a relic of a bygone era, there may be a place for it in your company. A Defined Benefit Plan could be a fantastic option for business owners who want to offer their employees a high level of retirement security. It’s particularly ideal if your business has a steady income and can commit to the long-term obligations of this type of plan.

Traditional 401(k) Plan

You may think a Traditional 401(k) Plan is just for giant corporations. But one might be just the right retirement plan for your business.
One of the main draws of a Traditional 401(k) is its tax advantage. As an employee, your contributions are pre-tax, which means they reduce your taxable income. As the business owner, your contributions are tax-deductible and can act as an attractive incentive for potential employees.
Regarding contribution limits: In 2023, employees can contribute up to $22,500, with an additional $7,500 catch-up contribution for those aged 50 and above. As an employer, you can match their contributions, helping your team build a healthy retirement nest egg.
A key point to remember is that a 401(k) is flexible. Your employees decide how much they want to contribute, and you can choose whether and how much to match. This flexibility can be a significant advantage for smaller businesses that must carefully manage cash flow.
Another advantage is that the 401(K) now offers company Roth matches, adding another tool to fine-tune tax strategies. Before the passage of Secure 2.0, employers could provide Roth 401(K)s, but not Roth matches.
Now, there are some complexities with managing a 401(k). They require annual testing to ensure compliance with IRS rules and may require more paperwork than other plans. But with the proper guidance, managing a 401(k) may be much more straightforward than you think.

In Conclusion

Retirement planning is no small task, and finding the right retirement plan for your business is a big move. From Solo 401(k)s to the more traditional pension, each choice offers unique benefits and drawbacks.
The right fit will depend on several things. This includes the size of your business, the stability of your income, how hands-on you want to be with administrative duties, and the perks you aim to offer your team. There’s no one-size-fits-all answer here – it’s about discovering which plan best aligns with your business goals and your team’s financial security.
Remember, picking a retirement plan isn’t a one-and-done deal. As your business evolves and grows, your retirement planning needs will change. Regular check-ins on your plan can ensure it still serves your business effectively and matches your shifting objectives.
Sorting through retirement plan options can feel like navigating a labyrinth. But you don’t have to be in it alone.
With a wealth of experience in retirement planning for businesses like yours, we’re here to help you make a well-informed decision that suits your unique needs and goals. Just click the button below to schedule a meeting!
Disclosures

Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies have the potential for profit or loss. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice.

A professional advisor should be consulted before implementing any investment strategy. WealthGen Advisors does not represent, warranty, or imply that the services or methods of analysis employed by the Firm can or will predict future results, successfully identify market tops or bottoms, or insulate clients from losses due to market corrections or declines. Investments are subject to market risks and potential loss of principal invested, and all investment strategies likewise have the potential for profit or loss. Past performance is no guarantee of future results.

Please note: While we strive to provide accurate and helpful information, we are not Certified Public Accountants (CPAs). The information in this article is intended for informational and educational purposes only and should not be interpreted as tax advice. It is crucial to consult with a CPA or tax professional to discuss you

Author

  • Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

    A Florida native, and full-time Sarasota resident, Ken founded WealthGen Advisors, LLC after spending more than fourteen years in the financial advisory industry. Ken holds multiple industry designations, as well as a master's degree in Financial Planning. Prior to founding WealthGen Advisors, Ken spent almost a decade in New York and then Texas as Vice President at The Capital Group, a $2T global investment manager serving institutional clients and pension funds.

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