As a business owner you are now responsible for setting up your own employee benefit plan. There is power in being able to customize a plan that is most suitable for you, your business and your employees; however, with the infinite amount of information there is out there, we understand that it can be overwhelming.
Our goal for this blog is to breakdown 5 different retirement plans you can set up as a small business owner, the tax advantages to these plans, who it is best suited for, and the benefits to the employee and employer.
We will begin with the most common plan for those just getting started as a solopreneur.
1. Traditional or Roth IRA
- Best for: Those starting out
- Contribution limit: $6,500 in 2023 ($7,500 for those age 50 and older)
- Tax Advantage: Your contributions to a Traditional IRA would be tax deductible, whereas, your contributions to a Roth IRA would have no immediate tax deduction BUT when you make withdrawals in retirement, they will be tax-free.
- Benefit to Employer: You do not need to have employees to open this account.
- Benefit to Employees: Both the Traditional IRA and the Roth IRA are retirement plans for individuals. You, as the employer, cannot set up a Traditional IRA or a Roth IRA for your employees. They will need to take action and open their own individual plan and contributions will NOT be made from payroll, but rather from a their personal bank account.
**401K Rollovers: Did you work for someone else as a W-2 before becoming self-employed? If you have left a previous employer, you can rollover your 401K into an IRA and continue making contributions on your behalf.
For those in business with their spouse and your spouse is registered as an employee of your business, you might want to consider this next option.
2. Solo 401K
- Best for: If your only employee is your spouse
- Contribution Limit: In a Solo 401K, you can make contributions as both the employer of your business and an employee of your business.
- You, as AN EMPLOYEE, of your own business can contribute
- Up to $22,500 (IF you’re age 50 or older your contribution limit is set at $30,000)
- You, as THE EMPLOYER, of your own business, you have the ability to contribute
- AN ADDITIONAL contribution up to 25% of your compensation with an OVERALL LIMIT set at $66,000 for 2023.
- You, as AN EMPLOYEE, of your own business can contribute
- Tax Deductions: Contributions are pre-tax so the distributions after 59 ½ would be taxable as ordinary income.
- Employee Contribution: In this case, it would be your spouse. Your spouse, as the employee, can contribute up to $22,500 in 2023 to this type of plan (IF they’re age 50 or older their contribution limit is $30,000). Now, you as the employer, you're able to contribute an additional amount to their retirement plan up to a total amount between your and your spouse's contributions of $66,000 for 2023. The limit is $73,500 if your spouse is age 50 or older.
3. SEP IRA
- Best for: If you have no or few employees
- Contribution limit: Either, $66,000 OR up to 25% of compensation or net (after tax) self-employment earnings.
- Tax advantage: You can deduct either your contributions OR 25% of net self-employment earnings or compensation. **Net self-employment income = Net profit – ½ (your self-employment taxes paid + SEP contributions)
- Since contributions were tax-deductible, the withdrawals from the account will be taxed as ordinary income in retirement.
- Since December 2022, Roth contributions are NOW ALLOWED.
- Employee: You as the employer will need to contribute an EQUAL percentage of salary for each eligible employee. Keep in mind, YOU ARE CONSIDERED AN EMPLOYEE HERE AS WELL.
- Example: If you put 10% of your salary to your SEP IRA, then you will also need to put 10% to your employee’s SEP IRA accounts.
4. SIMPLE IRA
- Best for: Larger businesses, UP TO 100 EMPLOYEES.
- Contribution Limit: $15,500 in 2023 (IF you’re age 50 or older your contribution limit is $19,000 in 2023)
- Tax Advantage: Contributions are tax deductible. Contributions made from the business to an employee’s account are deductible as a business expense.
- Legislation passed in December 2022, now allows for ROTH contributions to SIMPLE IRA’s.
- Benefit to Employees of Your Business: You, as the employer, will have an option of how you will make contributions for your employees:
- Either make matching up to 3% OR fixed contributions of 2% regardless of them making contributions or not.
- EXAMPLE: You have 50 employees, 25 of them are making contributions to their SIMPLE IRA.
- Scenario 1: You elect the up to 3% match option. Then, you, as the employer, will only need to apply the match to the 25 employees making contributions to their SIMPLE IRAs. You set the % you would like to match, up to 3%.
- Scenario 2: You elect the 2% fixed match. Then, you, as the employer, will need to match 2% of each employee’s salary and deposit that dollar amount into each employee’s SIMPLE IRA account. This will be for ALL 50 employees.
5. Defined Benefit Plan
- Best for: A self-employed individual with NO EMPLOYEES but with a high income and wants to save a lot for retirement
- Contribution limit: This will be calculated based on the benefit you’ll received at retirement, your age and expected investment returns
- Tax Advantage: Tax deductible.
- Employee: If you have employees, you will need to offer this plan to them as well and make contributions on their behalf.
Here are a few things to consider when choosing the right fit for you and your business:
- The amount you wish to contribute.
- Whether you would like to make contributions for you and your spouse
- Whether you have employees working for you and you would like to make contributions to their retirement plans
- Whether you would prefer to make tax-deductible contributions or tax-free withdrawals
To make a decision on which plan is best fit for your situation we recommend to consult with your Financial Advisor and your Tax Advisor. This is the team you will want by your side!
Your tax preparer will set up a tax planning strategy most suitable for your business, and your Financial Advisor will customize, implement and manage your retirement plan.