One-third of all business owners say they don’t see retirement in their future. If you are the owner or co-owner of a business, it may be hard to imagine a day when you stop working. You may find yourself so caught up in running your business that you neglect to plan for a way out. However, it's important to prepare for retirement so that one day, should you decide to step away from your business, you have a solid plan in place. You deserve to know that you will be financially well-off if you stop working.
For some business owners, the path to retirement is through the sale of their business However, many other business owners are also concerned with providing for both their retirement and their employees’. For this reason, many choose to invest in retirement income strategies. We’ve outlined several options below that you can choose from if you’re looking into possible retirement income strategies.
Roth and Traditional IRAs or Solo 401(K)
Roth and Traditional IRAs are an option for employers who want to save for their retirement without involving their employees. Anyone with income can set up a Traditional or a Roth IRA.
It is also possible to set up an IRA on behalf of your spouse. You can contribute to this IRA if you are married, file a joint federal income tax return, and your spouse earns less than you. This IRA is also not based on your income alone but on the combined compensation of you and your spouse. The amount that you can contribute will depend on your annual contribution limits. If you are contributing to a separate IRA for you and your spouse, then the combined compensation must be at least equal to the combined contributions.
If your business has no employees other than yourself and your spouse, then you are able to set up and contribute to a solo 401(k).
A SEP IRA allows most employers, including those who are self-employed, to set up a plan for yourself. This type of IRA must cover you and your eligible employees. To be eligible, an employee must be 21 or older, have worked for you for three of the last five years, and earn $600 or more annually.
In this plan, you contribute a uniform percentage of pay for each employee. You also have some flexibility amidst changing business conditions, as you may not be obligated to contribute each year. If you were using a SEP IRA in 2020, your contributions would be limited to the lesser of 25% of the employee’s pay, or $57,000.
If your business has 100 or fewer employees, you are able to set up a SIMPLE IRA plan. SIMPLE stands for a Saving Incentives Match Plan for Employees. In this plan, employees can make up to $13,500 in pre-tax contributions for 2020. If they are over 50 years old, they can contribute an additional $3,000, or a total of $16,500 this year. Each employee that has earned at least $5,000 or more in any two prior years and who is expected to earn at least $5,000 in the current year must be allowed to participate.
You as the employer are then required to make a contribution in one of two ways. Your first option is to match your employee’s contributions dollar-for-dollar up to 3% of each employee’s contribution. Your second option is to make a fixed contribution of 2% for each eligible employee.
Many business owners utilize 401(K) plans for their employees and themselves. Each employee who has worked at a business for one year is typically allowed to contribute to the plan. Employees can contribute $19,500 of their income if they are younger than 50 or $26,000 if they are older than 50.
As a business owner, you may also make employer contributions to your 401(k) plan. These can either be matching contributions or discretionary profit-sharing contributions. The limit for combined employer and employee contributions for any employee in 2020 cannot exceed the lesser of 100% of the employee’s compensation, or $57,000. If your employee is 50 or older, catch-up contributions are limited to an additional $6,000. Typically, these employer contributions are available for employees after a year of service, but they can be delayed if employer contributions are immediately vested.
There are many regulations to ensure benefits are not disproportionally benefiting higher-paid employees. One option to avoid having to perform vesting is to use a Safe Harbor 401(k) plan. Your contributions must be fully vested, and either match 100% of employee deferrals up 3% of compensation and 50% of deferrals between 3% and 5% of compensation or make a fixed contribution of 3% of an employee’s compensation regardless of if they contribute.
As a business owner, it is important to prepare for your future and care for your employees. While retirement may seem far off and setting up a plan may seem daunting, these options are ones that can help you. With so many options available to you, you can start building a plan custom to you and your business’ needs. If you have any questions, please call us at (716) 568-8568.
Vesting - giving an employee the right to a present or future payment, ie. pension benefits.
Broadridge Retirement Plans for Small Businesses.PDF