As a small business owner, planning for your retirement is up to you and you can contribute considerable sums to retirement planning.
Keep more of your money and lower your taxes. The amount contributed to a retirement plan is a tax-deduction in the year of the contribution and grows tax-deferred.
Time is Money
In addition to your contributions, the compounding of interest, accumulation of dividends, and capital gains allow your account to generate earnings on top of earnings.
Attract and Retain Employees
Offering a retirement plan will differentiate you from other small business employers and help your business flourish with top talent.
Which type of retirement plan is best suited for you depends on three factors
How much you can save into a retirement plan?
How many employees you have and their demographics.
Whether you're setting up the plan during the tax year or when filing.
Up to $6,000 Annually
If you can save no more than $6,000 annually, there is any easy solution for you to put away some money into a retirement plan. You might be just starting your business or the business is starting to generate more cash flow for you. These types of plans are easy to set up.
A traditional IRA allows you to contribute up to $6,000 annually plus $1,000 catch-up contribution if you're 50 or older. Contributions are tax deductible and grow tax-free until withdrawn. Withdrawals are taxed as income in the year it is taken.
A Roth IRA is funded with after-tax funds so it is best used when income tax rates are expected to be higher in years when withdrawals are taken. Funds can be withdrawn tax-free after age 59.5. The Roth IRA does have income limits for eligibility.
For contributions between $6,000 and $57,000
If you can contribute anywhere between $6,000 and $57,000, you should consider moving beyond only using a Traditional or ROTH IRA. Consider adding a Solo 401k or Simplified Employee Pension (SEP) IRA. These retirement plans have higher contribution limits which translates into larger tax deductions and greater potential growth over the long term. Both plans have a maximum contribution limit of $57,000 for 2020 and will depend on the plan and the specific business.
This account is best for self-employed people or owners with few or no employees. This account is relatively easy to set up and maintain. The contribution limit is slightly lower than that of a Solo 401k and generally speaking, you can contribute up to 25% of your adjusted gross income. One big advantage is that you can set it up for the prior year as long as it's done before you file in October. No catch up contributions are allowed and there are rules for contributing to other employees.
A Solo 401K has become easier to set up and maintain and the fees have decreased. In this plan, you can contribute $19,500 as an employee of the business plus the employer can contribute another 25% of compensation. In this plan, consider yourself to be both employee and employer. With profit-sharing contributions you could contribute $57,000 in total, per person, per year. If you are 50 or older, you can also contribute another $6,000 per year. You cannot have any employees with a Solo 401k plan.
A Simple IRA allows for contributions of up to $13,500 for 2020 plus a catch up contribution of $3,000 if 50 or older. The plan can be set up so that the employer matches employee contributions up to 3% or provides a fixed contribution of 2% regardless of whether employees contribute. Contribution limits are lower for the business owner than the limits on other plans but the plan is relatively easy to set up.
For contributions above $57,000
If your business is successful and you're generating great profits and you can save more than $57,000 per year, you should consider a Defined Benefit Plan or Cash Balance Pension Plan. Both allow for contributions of greater than $57,000 per year depending on the cash flow of the business. These plans have minimum funding requirements so you need to be prepared to make substantial contributions for a few years.
Defined Benefit or Cash Balance Pension Plan
The maximum allowable contributions depend on your age and income and in some cases, can be above $250,000 or more. The drawback is that pension plans are costly to set up and run but can generate higher benefits than the cost to implement. You might also have to contribute for employees who meet certain requirements although plans can be designed to be fair to employees while generating the most benefit for owners.
Not sure which plan is best for you?
Contact us to schedule a free consultation including several plan options that you could consider.