How to save for retirement if you’re a small business owner

As a small business owner, you love what you do. Just remember that you may not want (or be able) to do it forever. As important as it is to re-invest in your business, it’s also important to make sure you have enough money saved for a comfortable retirement. 

You don’t have a company pension or 401k plan that makes retirement planning easy and automatic. The good news is that you have more flexibility regarding retirement savings than you might if you worked for a big corporation. Plus, retirement plan contributions are often tax-deductible, which can benefit your bottom line. Here’s what you need to know. 

Ask yourself some questions

There are many different options for a retirement plan for small businesses. To decide which one is best for you, ask yourself these questions:

1. Do you have, or do you plan to have employees?
2. If so, do you want to include them in your plan? 
3. Is your business profit relatively stable from one year to the next, or does it vary a lot?
4. How long do you plan to work before you retire?

The answers to these questions will help you determine which retirement plan is the best for you and your employees if you have them.
 
Related: Learn how your small business can compete in a tight employment market

Plans for sole proprietors

If you don’t have employees, and don’t plan to, the only retirement you need to worry about is your own. Here are some options for you. 

A traditional or Roth IRA

If the amount of money you can or will save is modest, the simplest type of retirement plan is an Individual Retirement Account or IRA. With this type of plan, you can save up to $6,000 in 2022, plus a $1,000 ‘catch-up’ contribution if you’re 50 or older. 

There are two types of IRAs – traditional and Roth. You can choose one or both, but your total contribution cannot exceed the $6,000 limit (plus the catch-up if it applies. The difference between the two types has to do with how the money is taxed. 

In a traditional IRA, you contribute pre-tax dollars, meaning that you can deduct your contribution from your taxable income. (Restrictions may apply if your spouse is covered by an employer plan.) 

Here’s an example. Suppose you make $50,000 in income from your business. You contribute $5,000 to your traditional IRA. You will be taxed on $45,000 (your income minus your contribution), rather than $50,000. However, after you retire and start taking money out of your IRA, you will pay income tax on the money you take out. The advantage is that your money has grown tax-deferred all that time.

In a Roth IRA, you contribute money that you’ve already paid taxes on. Using the above example, you’d pay income tax on the whole $50,000 you earned, but you could still put that $5,000 in a Roth IRA. Then, when you withdraw the money in retirement, you don’t pay taxes on it. This means that all the money you’ve earned on your investment is also tax-free. 

So, how do you know which one is best for you? If you need to reduce your taxable income as much as possible, go for the traditional IRA. If you don’t, or if you have quite a while before you retire, choose the Roth. 

Advantages: 

• Easy to set up, low or no fees.
• Contribute as much or as little as you want, any time during the year.

Disadvantages:

• Contribution limits are low, so you may not be able to save as much as you want to.
• It’s only for the individual, not employees.

Best for: Younger owners who have some time before retirement, or those who will be saving a small amount. 

Solo 401(k)

A solo 401(k) is an account that can cover the business owner only, plus their spouse if they are also employed by the business. Whether you have employees or not, you can have a solo 401k, but your employees can’t participate in the plan. 

You can defer up to $22,000 (plus a $5,000 catch-up contribution if you are 50 or older) in 2022. You can’t defer more than your earned income. 

Advantages: 

• Higher contribution limits than IRAs. 
• Relatively easy and inexpensive to set up. 

Disadvantages:

• If you want to offer a retirement plan to employees, you’ll need to start a new plan. 

Best for: Sole proprietors (plus a spouse) who want to save more than they can with an IRA. 

Related: Are you self-employed, a sole proprietor, or both? 

Retirement plans for business owners and employees

There are also retirement plans that will let you include your employees. In some cases, the employee will contribute part of their salary. In other cases, you, the employer, will contribute to the employee’s account as part of their compensation. In still other cases, the employee can contribute and the employer can match all or part of their contribution. 

SIMPLE IRA

The Savings Incentive Match Plan for Employers, or SIMPLE, IRA, lets employees (with 100 employees or fewer) contribute to their retirement savings and gives employers the option to match some or all of their contributions. A SIMPLE IRA is easy and inexpensive to set up and operate, making it a good choice for small employers. 

Here’s how it works. The employee can elect to contribute a percentage of their salary, before taxes, to their SIMPLE IRA account. The employer can then match up to 3% of their salary. (This matching contribution helps small employers compete with larger companies that might have a 401k with a company match.) The company must match the same percentage for each employee who contributes and must also contribute 2% of salary for any employee who doesn’t contribute to their own account. 

For example, ABC Company has two employees in addition to the owner. Bill, the owner, sets up a SIMPLE IRA for the company. Jill, one of the employees, contributes 3% of her $50,000 salary to her account, and Bill matches it. So, she contributes $1,500, and the company contributes $1,500 to her account each year. Jack, the other employee, chooses not to contribute to his account. ABC Company contributes 2% of his $50,000 salary to his account, so he gets $1,000 in his account even though he doesn’t contribute. Bill can also contribute to his account, and the company will match his contribution at the same rate as Jill’s. 

The contribution limits for SIMPLE IRAs are higher than for regular IRAs. An employee can contribute up to $14,000 per year, plus a $3,000 catch-up contribution if they are 50 or older. 

Advantages:

• Higher contribution limits than traditional IRAs.
• Employer can contribute. 

Disadvantages:

• Employer must contribute whether the employee does or not. 

Best for: Employers who want to include contributions as part of every employee’s compensation. 

SEP IRA

A Simplified Employee Pension, or SEP, IRA does not accept contributions from employees, only from employers. You must contribute the same percentage of compensation for each eligible employee. That contribution can be up to 25% of compensation or $61,000. There are no catch-up contributions for SEPs. 

Advantages:

• Easy to set up and administer
• High contribution limits

Disadvantages:

• Employees cannot contribute to their own accounts

Best for: Employers who want to contribute as part of each employee’s compensation. 

401(k)

A 401(k) plan allows employees to defer part of their salary, before taxes, into a plan set up by the employer. The employee can choose the amount they contribute (up to the limit of $20,500 in 2022, plus a $6,500 catch-up for those 50 and over). The employer can choose to match some or all of the employee’s contribution. There are usually multiple investment options in a 401(k) plan, so employees can choose how much risk they want to take. 

Here’s an example. Joe sets up a 401(k) plan for his company, which has five employees. Joe and four of his employees choose to participate in the plan. Each employee decides what percentage of their salary they want to contribute. Joe matches the first 3% of their contributions dollar for dollar. Sue, who earns $50,000 per year, defers 5% of her salary into her account, or $2,500. Joe matches the first 3% of her contribution, or $1,500, which is added to Sue’s account. 

A 401(k) is more complicated to set up than some other types of retirement plans, so a company will often use a third-party administrator (TPA) to manage the program. 

Advantages:

• Allows for higher contributions than some IRA plans. 
• Allows for employers to contribute. 

Disadvantages:

• More complex and costly to the employer than some other plans. 

Best for: Businesses with multiple employees who will participate. 

Establishing a retirement plan for yourself and your employees if you have them is a smart way to plan for your future. Consult a financial advisor or tax preparer for more information on the best retirement savings plan for your business.