You may think selling your business is your retirement plan. But selling a business isn’t easy. In fact, according to the International Business Brokers Association (IBBA), up to 90% of businesses never sell at all.
As a Financial Coach and retired CPA, I often get asked, “What is the best way for small business owners to save for retirement?” The good news is, small business owners have several options to choose from. Let me give you an overview of your options and how each works.
Solo 401(k): This retirement plan allows a business owner with NO employees (except a spouse) to contribute up to $61,000 in 2022 with an additional $6,500 catch-up contribution (if you’re 50 or older). This breaks down into TWO contributions: (A) employee deferral of $20,500 (for 2022) plus (B) employer contribution of as much as 25 percent of the business’s income. One attractive trait about the solo 401(k) is that your employee contribution is not limited to a percentage of your pay. That is, you can immediately contribute all your salary to the plan up to the annual maximum ($20,500 for 2022). Then you can make the employer contributions at the 25 percent rate. This setup allows you to quickly stack money into your solo 401(k) plan. You can set it up as a traditional 401(k) with pre-tax contributions which reduce your taxes now, OR contribute after-tax funds, Roth 401(k). Remember the Employer Contribution reduces your business taxes, even as you save for retirement.
You must establish your Solo 401(k) by December 31st and make your employee contribution by year-end for it to be deductible in the given year.
SEP IRA (Simplified Employee Pension Individual Retirement Account): You can establish this if you are a solo business owner or have employees. It must be established by the business’s tax filing date (including extensions). However, only the business owner makes contributions, not the employees. Employers can contribute up to 25% of each eligible employee’s gross annual salary and up to 20% of their net adjusted annual self-employment income if they are self-employed, provided the contributions don’t exceed the max contributions (for 2022 $61,000 or up to 25% of compensation, whichever is less). Therefore, the business owner contributes the same % of each employee’s salary. Money going into the plan is tax-deductible and can grow tax-deferred until retirement. A SEP may not be desirable because it provides immediate vesting, it doesn’t allow loans to be taken out against it, and employees may be eligible after as little as a week. There are no ROTH options and no catch-up provisions. The same rules apply as traditional IRA for distributions and investments.
Simple IRA (Savings Incentive Match Plan for Employees): This retirement plan is for small business owners with less than 100 employees. It’s basically a small-company version of a 401(k) plan. Employees invest a portion of their pre tax salary into an individual account (think IRA) and receive mandatory employer contributions. It’s simpler and cheaper than a 401(k), but employee contribution limits are lower than 401(k)s. For 2022 the employee contribution limits are $22,000 plus $3,000 catchup. Employer mandatory contribution is typically 2% of employee’s gross pay. Employer’s get a tax deduction for their contributions to employees’ accounts.
You can set up a SIMPLE IRA plan effective on any date from January 1 through October 1 of a year, provided you did not previously maintain a SIMPLE IRA plan.
IRA or ROTH IRA: Lastly, everyone with earned income is eligible to establish a traditional IRA which is funded with pre-tax money so you get a tax deduction now, or Roth IRA. You use after-tax money to fund a Roth IRA and don’t have to pay taxes when you withdraw it.
A little known IRA is the SPOUSAL IRA. If you have earned income and your spouse is unemployed, they can open and fund an IRA or Roth IRA, too! You just have to make sure you have enough earned income to cover the contributions to both IRA’s.
So that’s a lot of retirement technical info.
If you’re confused, schedule a call with me and I’ll help you decipher the details.