Which One of These Small Business Owner Retirement Plans Is Right for You?
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As a hardworking business owner, choosing retirement savings options goes beyond merely ticking a box on an HR document. Similar to other decisions you’ve had to make on your own, retirement is another crucial financial topic you must diligently explore to set you and your business up for success.
Small business retirement plans vary in terms of structure, benefits, and suitability, depending on the size of your business and team, your financial situation, and your goals. Choosing the right one for your business can feel daunting, but the sooner you decide which plan is right for you, the better handle you’ll have on your retirement planning.
Why Early Retirement Planning Is a Must for Business Owners
Small business owners need to prioritize their retirement planning largely because it affects their long-term personal financial stability. Most entrepreneurs invest (and reinvest) their personal savings into their business, which can greatly help their business in the startup and scaling stages, but can also hinder them from saving for the long term. A retirement plan can ensure their future selves are taken care of while the business grows.
Early retirement planning can also help small business owners manage their taxes more effectively. Some retirement plans help entrepreneurs reduce their taxable income through retirement contributions and experience tax-free or tax-deferred growth.
A robust and diversified retirement plan can also help mitigate the inevitable risks that come with small business ownership such as shifts in market demand and economic downturns. Additionally, a retirement plan, along with other attractive benefits, can help small business owners allure talented and experienced employees.
Understanding Your Retirement Savings Options
Below are four different small business owner retirement plans that offer various benefits depending on your unique needs and desires.
1. Solo 401(k): Your Tax-Savvy Companion
This retirement savings vehicle is for solopreneurs with no full-time employees. Contributions to a solo 401(k) are made pre-tax, lowering current taxable income. Alternatively, if the solo 401(k) plan comes with a Roth option, post-tax contributions will grow tax-free and retirement withdrawals will be tax-free.
With this plan, small business owners can make contributions both as the employer and employee. In 2024, individuals under the age of 50 can contribute up to $69,000 - with an extra $7,500 catch-up contribution allowed for those over 50. Within the $69,000 limit, the “employee” part can contribute up to $23,000 and the “employer” side can contribute an additional 25% of the net self-employment income.
These flexible retirement plans are relatively straightforward and can even provide small business owners with loan options in case of financial hardship.
Who this plan might be best suited for: A solo 401(k) may be a great opportunity for those with a one-person small business, a freelancer or even a side hustle. It can also work for those businesses being run by a married couple, making it a great way to save money for retirement.
2. Simplified Employee Pension (SEP) IRA: Flexibility Meets Tax Benefits
The SEP-IRA can be utilized by any business, regardless of their size, and self-employed individuals and has low administrative costs. This particular plan allows business owners to make tax-deductible contributions to their employee’s retirement, usually after some basic requirements have been met by the employee such as being employed for a certain number of years.
A hallmark feature to be aware of with this plan is that employees cannot contribute to their own SEP-IRA retirement plan, only their employer. Business owners can contribute up to 25% of each employee’s income or $69,000 for 2024 (whichever is less). The employer must contribute to each employee’s account equally based upon a certain percentage of the employee's wages.
Small businesses with fluctuating income may want to choose this plan as they can contribute higher amounts to their employees’ SEP-IRA during plentiful years and less during lean times, thanks to the plan’s flexible annual contributions.
Who this plan might be best suited for: Although available for small businesses of any size, this plan is typically geared towards self-employed individuals and small business owners with few or no employees who want a very flexible and low cost option.
3. SIMPLE IRA: Simplicity with a Side of Savings
The SIMPLE IRA stands for Savings Incentive Match Plan for Employees and is a straightforward and effective retirement savings solution for businesses with 100 or fewer employees. This plan does not require the hefty start-up and continual operational costs that other conventional retirement plans have.
This plan allows small business owners and their employees to make pre-tax contributions, thereby reducing current taxable income (withdrawals in retirement are taxed as ordinary income). In 2024, the annual contribution limit is $16,000 for individuals under 50, while those 50 and older can contribute an additional $3,500.
Employees have the option to contribute to their own retirement savings, but under this plan, the employer is required to contribute at least 2% each year. This benefit is more akin to that of large companies.
Who this plan might be best suited for: Small business owners with fewer than 100 employees who want to offer a retirement plan to their team on a relatively inexpensive level.
4. Defined Benefit Plan: The Big Kahuna of Tax Deductions
The defined benefit plan (also known as a pension plan) offers employees a fixed, predetermined retirement benefit. The specific payment amount depends heavily on the employee’s tenure, salary, and age rather than investment returns.
With this plan, the employer has a very large amount of responsibility because the plan is completely funded and managed by them. They must ensure there will be enough money to pay out when their employees hit retirement age.
Contributions made to defined benefit plans are tax-deductible and assets grow tax-deferred. Employees must pay taxes when they start to receive their benefit payouts. This retirement plan offers the highest contributions (and deductions) available to small businesses.
The plan requires more care and know-how when it comes to administration, so it may work best for businesses with a dedicated financial officer to keep tabs on maximizing tax benefits.
Who might this plan be best suited for: Older, highly compensated business owners, partners and key employees who are in their peak earning years with a shorter time to retirement.
Discover More Small Business Owner Retirement Strategies
Exploring small business owner retirement plans is not just about planning for the future, it’s about unlocking your business’ full potential. You want to ensure your hard-earned success is sustained and that your employees are well taken care of.
At Financial Fitness Coaching, we take a personalized approach to your small business strategies, offering comprehensive solutions and guidance. Many brilliant business owners benefit from tagging in a financial expert to help them plan.
You can start by downloading our “CFO Checklist” to help you manage the weekly tasks of being your own CFO. It’s the practical first step toward improving your business’ financial fitness.