Typically, a person receives retirement options for 401(k)s and IRAs through their employer. If you own your own small business, you do not receive that same option without a few changes. People who are self employed are fully responsible for their own retirement planning. You must be strategic with your choices for a retirement planning strategy for yourself and your employees, if you have any.
401(k)s and IRAs are the traditional choices for retirement savings accounts. An IRA that is available for small businesses is a SIMPLE IRA. SIMPLE stands for “Savings Incentive Match Plan for Employees.” Employers have the ability to choose whether or not to make a non-elective contribution of 2% of the employee’s salary or a dollar based matching contribution of your employee’s contribution up to 3% of their salary. Employees are allowed to contribute a maximum of $13,500 annually. Employer contributions on a SIMPLE IRA are tax deductible.
Another option is a SEP IRA. SEP stands for simplified employee pension. In 2020, employees were able to make pre-tax contributions up to 25% of their income or $57,000. The employer contributions are also tax deductible. A small business owner could also save for their own retirement through a Roth or traditional IRA if they do not have employees or do not want to offer retirement benefits.
As a self-employed small business owner, you could have a solo 401(k), also known as a one participant 401(k). This type of account is specifically designed for a business owner who does not have employees. The total annual contribution limit for 2020 on solo 401(k)s was $57,000 and planned to be $58,000 for 2021. An advantage to this account is you are able to pick what tax advantage you want. If you choose the traditional IRA where our distributions will be taxed as income but your contributions lower your income the year they are made. If you choose a Roth IRA, you can have tax-free distributions in retirement.
As a small business owner, you are fully in charge of your retirement savings plans. If you receive self-employment income, you may want to have a defined benefit plan or a SEP IRA to shield yourself from current taxation on your self-employment income. If you do not see a reason to limit your options, you should consider 401(k) accounts.
Speaking with a financial professional can be extremely beneficial for a small business owner struggling to decide what to do about retirement planning. A financial professional will be able to evaluate your specific small business and income to recommend the best retirement planning options for you and your employees.