When choosing investments, it can already be difficult enough to determine which type of retirement plan is right for you. If you operate a small business, your retirement plan options will not necessarily be the same as they are for an individual who does not own a business. Most people who run small businesses do not even know that there are special retirement vehicles that they can use to prepare for their retirement that can also help any employees do so. Regardless of whether you are a sole proprietor or you have a few employees for whom you would like to offer options, consider retirement accounts geared specifically toward small businesses.
The SEP IRA
Perhaps the most common option available to small business owners when it comes to retirement is the SEP IRA. SEP stands for “simplified employee pension,” and it is an employer sponsored plan that any company with one or more employees is eligible for. You do not need to be a large business to qualify.
It is often used by business owners who have no employees. You would only need to make an employee contribution if you have employees who have been working with you two of the last five years.
SEP IRAs are simple and easy to manage, and you are not required to make contributions each year like you might be with other types of accounts. This is a tax-advantaged retirement option, which means that the money that the business owner contributes to their own account and any employees’ accounts is tax deductible.
As an additional bonus, growth in the account accumulates in a tax deferred state, which helps avoid income tax or capital gains taxes while the money is growing. You will be taxed when you withdraw the funds as if they were normal income, and you should expect to leave those funds alone until you are 59 ½ years old. Otherwise, you may incur a penalty of 10% for withdrawing the money or taking distributions.
You will be able to contribute up to 25% of the compensation you make in a year, which cannot exceed $61,000 as of 2022.
A Self-Employed 401(k)
A self-employed 401(k) is similar to a SEP IRA, but the employee requirements are different. Self-employed 401(k)s are only for business owners who operate alone (or with a spouse) and have no other employees. Like SEP IRAs, the 401(k) can be funded with employer contributions, and you cannot withdraw your funds until a “trigger” event occurs like becoming disabled or reaching that critical 59 ½ age benchmark.
However, like most 401(k)s, the self-employed option also comes with a funding cap, which means that you cannot contribute as much as you want at any time. You will be able to contribute up to $20,500 per year with a $6,500 catch up contribution for those 50 years or older. You also have an additional profit sharing contribution that you can utilize in the Solo 401(k) that will allow you to contribute an additional 25% of your compensation up to the max limit of $61,000 for the 2022 year.
It is highly recommended that you work with a CPA, tax professional or financial advisor when figuring out how much or what type of retirement contribution you should be making on an annual basis.
A Traditional IRA
A traditional IRA is similar to a SEP IRA in that it works for small business owners, and contributions can be made as pre-tax contributions. However, there is some additional flexibility in that individuals may contribute after-tax dollars as well if they wish.
However, annual contributions are not mandatory for a traditional IRA, with a cap of $6,000 per year as of 2022. Those who are above the age of 50 can contribute $7,000 per year to help them catch up.
The Individual 401(k) and IRA Options
If you operate a small business and you are the business’s sole employee, you can of course choose to utilize individual retirement plans that have nothing to do with your company. These are not small business-specific accounts, so they may not carry some of the advantages that a business-related option might. An individual IRA is one such option. The IRA limit is currently $6,000 per year as of 2022.
However, an individual 401(k) plan – sometimes called a solo 401(k) – does allow you to have far more flexibility with the different types of contributions that can be made. You may contribute to this plan as both an employee and as the business, so this is a powerful option if you would like to take full advantage of the maximum caps that you can invest in both categories. You may contribute 20% of your net earnings as profit sharing as the employer as well as a maximum of $20,500 as the employee as of 2022.
The Financial Professionals Can Help You Make the Right Choice for Your Business
Choosing the right retirement account for your small business does not need to be difficult. You can always seek guidance from financial professionals like those at Inflection Advisors who listen to your entire story and make recommendations accordingly. Reach out to learn more about our services or to schedule an appointment to get started.
