No matter your age, planning for retirement is essential to your future livelihood. While saving for retirement has become more simple over the last few decades through the spread of workplace options, entrepreneurship and self-employment open up a new set of options. Learn more about 3 retirement plan options for entrepreneurs.
As a business owner (especially a new one!), managing all of your business finances might be overwhelming. We don’t blame you if saving for retirement is dead-last on your list of things to do. But saving for retirement as an entrepreneur or small business-owner shouldn’t have to be difficult. In fact, as someone who is self-employed, you actually have access to a wider set of retirement plan options! All of which offer greater incentive to saving.
Read on to learn about 3 retirement plan options for entrepreneurs.
1. Solo 401(k)
The benefit of the solo-401(k) is that, as the sole-proprietor and your own employee, you can contribute twice: through your employee contribution and your business contribution. Note: this is only an option if you have no employees.
Much like the traditional 401(k), there is a cap to how much you can contribute as an employee. In 2022, your total employee contributions cannot exceed $20,500 (remember: these cap contributions change annually, so you’ll want to stay up to date!). If you are over the age of 50, you have a higher cap, with the idea that the government wants you to catch up. Under this age bracket, your cap would actually be $27,000.
However, on top of this employee contribution, your business can also contribute 25% of your net adjusted self-employed income (i.e. what your business earns after expenses, etc.), with a max income limit of $305,000 (for 2022) annually that you can consider. If you’re an S-corp, you can contribute up to 25% of your compensation.
This $61,000 contribution limit for a solo 401(k) in 2022 includes both the employee and employer contributions. So, between profit sharing, employee deferral, and company match, the maximum that could go into a 401(k) for one person in 2022 is $61,000. Or $67,500 for business owners over the age of 50.
You also have the option of either a traditional solo 401(k), or a Roth solo 401(k). Remember: under a traditional plan, your contributions will go into your account tax-free, your contributions will grow tax-free, but you will be taxed upon withdrawal, at the tax rate you fall under when you start to withdraw. Under a Roth plan, your contributions go after tax, your contributions grow tax-fee, and you withdraw tax-free.
2. SEP IRA
A simplified employee pension (SEP) IRA is an account designed for sole-proprietors (aka probably you if you own your own business!). This is perhaps one of the most common retirement plans among entrepreneurs, because of its simplicity and straightforwardness. Costs to set these up are low, and your investment options are wide. This is a solid option for entrepreneurs or small business owners with little to no employees.
In many ways, it is similar to a traditional IRA. The first main difference is that you as an employee cannot contribute. Instead, your employer funds this account. But remember: as the sole-proprietor, you are both the employee and the owner! The second difference is that your contribution limit is significantly higher: $61,000 or 25% of your compensation as an employee of your business, whichever is lower. The max income limit for the SEP IRA is also $305,000, like with a solo 401(k) These contributions are also tax-deductible, with the caveat of having to pay taxes upon withdrawal. Keep in mind that your personal cap to contribute may fluctuate year to year based on your adjusted income.
For a deeper dive on contribution rules, eligibility, withdrawal, and distribution rules, we like this article from The Motley Fool.
3. SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is also very similar to a traditional IRA, with the primary difference being the contribution limit. For this retirement account, the contribution limit is $14,000 in 2022, with an extra $3,000 if you are over 50 (as the catch-up).
Another key difference between the SIMPLE IRA and the SEP IRA is who can contribute. Through the SIMPLE IRA, both the employer and the employee could contribute.
This is a good option over the SEP IRA, for example, if you believe your business will be expanding in the near future, as it allows for a retirement account for your employees (without the heavy administrative fees and tasks associated with a traditional or Roth 401(k)). Note: if you have employees, you will be required to make a 3% match for employee contributions.
The Bottom Line
The government has created incentives for business owners. As a self-employed person, you are missing out on wealth-building opportunities if you do not explore these retirement planning options. Don’t let the high contribution limits of these plans scare you; your investment plan is unique, and the worst thing to do is not invest at all. As always, consult with a financial planning or tax professional when thinking through your unique investing and retirement strategy.
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It’s interesting to know that business owners can have an option where they can contribute to their retirement without any tax fee included in it. I can imagine how helpful this would be for entrepreneurs to have something they can look forward to when they grow old. They are probably working hard to have a comfortable life when they are not fit to work anymore, so I hope they talk to a retirement planner about this option if they are interested in it.