Small business retirement plan
Options for growing a nest egg
Small business owners looking to save money for retirement have a few options. Here are details on three of the most common plans to help you make the right decision to fund your golden years.
Solo 401(k)
The self-employed or solo 401(k) affords the opportunity to salt away as much as $54,000 per year, depending on your income. For those over 50, the annual contribution limit is $60,000. And while a solo 401(k) can be a convenient option to ramp up your retirement savings, it still requires a little more effort in terms of administration and making the right choices to optimize your experience.
When you’re considering setting up a solo 401(k), there are plenty of options. Many financial institutions and asset managers provide these plans, but the difference in offerings can be marked.
One of the benefits of a solo 401(k) is the opportunity to self-direct investments. For the more sophisticated investor, this can be particularly meaningful, as he or she is free to invest in any product or asset class. Whether it be stocks and bonds or assets like hedge funds, precious metals or private equity, the account holder has a vast range of choices.
But some institutions limit the investment plan options they make available to institution-directed plans, which allow the retirement investor to purchase only traditional products like equities and mutual funds. If you’re not interested in investing in more exotic asset classes, these financial institutions will likely be able to satisfy your needs in a cost-effective manner. But more sophisticated investors will be better served by open architecture plans that afford the broadest range of choices.
Self-direction offers other benefits as well. The ability to borrow against a solo 401(k) is one of the options that most small business owners appreciate. If you opt for an institution-directed plan, you may find any borrowing plans stymied.
SEP IRA
If you run your own business and plan to stay small, a Simplified Employee Pension (SEP) IRA is one of your best options. These retirement plans are popular with sole proprietors, allow for considerable annual contributions and are easy to establish. You can go online with almost any brokerage firm, bank or asset manager like Fidelity or Vanguard and open an account with no fuss. Annual fees are typically low, and the account holder pays a set fee for making trades.
The contribution limit is very generous, particularly compared to Roth and traditional IRAs. Put away as much as 25 percent of net income up to $54,000 for 2017. If you’re over 50, you can also make a catch-up contribution of an additional $6,000 per year, bringing the total annual contribution up to $60,000. This cap increases regularly to account for inflation.
If you’re planning to establish a SEP IRA, you should do it by April 15 for the previous tax year. Funding is very flexible, and you don’t need to fund the plan until you are ready to file your taxes. If you enjoy the happy surprise of earning more money than you expected, you can up your contribution and reduce your tax bill accordingly.
When it comes to making contributions for employees, you will be the only one doing so. In this plan, employees don’t contribute. If an employee is age 21 or older, has worked for you in three of the past five years and receives at least $600 in annual salary, he or she is eligible for inclusion in the plan. While you don’t have to fund contributions every year, you’re obligated to do so each year you contribute to your own account, and you must do so in an equal amount for every person you employ.
Roth IRA
As a small business owner, you can contribute not only to your company’s 401(k), SEP or SIMPLE IRA, but to a Roth IRA too, if you meet the income restrictions. By augmenting your retirement savings strategy with a Roth IRA, you’ll be able to maximize your retirement savings in tax advantaged accounts to the full extent that the law allows.
When you contribute to a Roth IRA, you fund the account with after-tax dollars. Because you’ve already paid tax on the money you’re investing for your future, when that future finally arrives you can withdraw the funds from your account without paying additional taxes.
With other retirement accounts, the distributions you begin to take at age 70 are taxable. The tax you pay will be dependent upon your tax bracket at the time of distribution. Although many people anticipate that their tax bracket will be lower, this is not always the case. As you age, you can lose important deductions.
Another benefit to the Roth IRA is that you can continue to contribute to the account at any age, even past retirement, as long as you are earning taxable income. If you’re not working but your spouse is, your spouse can continue to contribute to the account on your behalf.
The bad news is that once your income hits a certain level, you’re no longer eligible to contribute to a Roth IRA. Eligibility is based on your modified adjusted gross income.
Roth IRAs differ from other types of IRAs in two other important ways. Should you find yourself in need of funds, you can withdraw your Roth contributions any time for any reason at all. However, if you want to withdraw investment earnings before the age of 59 for any non-qualifying reason, you’ll pay a penalty.
And if you have a Roth IRA, you’re not forced to begin taking required minimum distributions at age 70, nor are you prohibited from continuing to make contributions.
One of the benefits of the solo 401(k) is the opportunity to self-direct investments.