When you’re an entrepreneur, it’s easy to put off retirement planning. You may not have enough money to contribute to personal accounts, or you may utilize them to fund your startup. However, the longer you wait, the more difficult it will be to catch up.
Your planning approach should be tailored to your stage of business, incorporate a variety of funding options, and be reviewed by a financial expert. Furthermore, understanding if you want to sell the firm, close it, or pass it on to another individual should be considered from the start.
Being self-employed provides some independence, but it should not be used as an excuse to avoid preparing for retirement. In fact, it makes saving money even more important: unlike an employee who may have access to a 401(k), you’re on your own.
And while you may believe you will eventually sell the business and utilize the proceeds to pay for your retirement, what if you do not? Consider a retirement account not only as a safety net but also as a tax-advantaged tool to reduce income during your peak earning years.
Here are the specifics on some of the finest retirement plans for entrepreneurs, including how much you may save and which plan could be ideal for you.
Retirement Accounts For the Entrepreneurs
One of the downsides of being self-employed is that you don’t automatically get the perks offered by many employers, such as a 401(k) plan with a company match on your contributions. But in some regards, self-employed retirement plans can vastly exceed those regular options.
Here are three of the most popular defined contribution plans and who could find them useful.
The solo 401(k) gives you all the advantages of a company 401(k) plan and then gives you even more benefits.
You can select traditional or Roth 401(k) options, meaning you’ll get the ability to contribute before-tax or after-tax dollars. You can invest in virtually any asset class, too. Pick a broker that offers a free solo 401(k) – Fidelity and Charles Schwab are good choices – and you won’t pay extra fees.
With a solo 401(k), you can make an employee contribution – up to $22,500 in 2023 – as well as an employer contribution of up to 25 percent of your company’s profits, up to a total deposit of $66,000 between the two. Those aged 50 and older can add an additional $7,500 as a catch-up contribution.
As you can see, you can quickly go above where a company’s 401(k) plan usually tops out.
Who it may be best for: This plan works only for one-person businesses or those with one person and a spouse. It may work well for those with a side gig as well as those earning a lot of money.
A SEP IRA allows the self-employed to create a retirement plan for themselves as well as employees. This kind of plan offers a tax-deferred or tax-free way to save – on either a pre-tax or after-tax (Roth) basis – but supercharges it, with a $66,000 maximum annual contribution limit in 2023. And using a SEP IRA won’t preclude you from using a traditional IRA or Roth IRA (which you really should do).
A SEP IRA allows the business to make employer contributions to employees, including the self-employed person. The business can contribute the lesser of 25 percent of its profits or the annual maximum. It’s a widely available plan, with many brokers offering access. However, all employees must receive the same percentage contribution.
Who it may be best for: Better for the high-earning self-employed, especially those in one-person outfits.
The SIMPLE IRA is an easy way for small employers, including the self-employed, to offer employees a retirement plan. The SIMPLE IRA can be easier for an employer to set up than many 401(k) plans, which have complex rules. Employers with 100 employees or fewer earning more than $5,000 can set one up.
Read Also: Determinants of Corporate Individual Payouts
The SIMPLE IRA uses the rules of a traditional IRA, so it’s tax-deferred and has the same withdrawal requirements at retirement. Employees can have wages deducted from their paychecks and can defer up to $15,500 annually, with those over age 50 allowed a $3,500 catch-up contribution, as of 2023.
Employers must add to the account, and they have a couple of choices:
- They can match contributions up to 3 percent of salary.
- They can contribute up to 2 percent of a worker’s salary up to the annual compensation limit of $330,000 in 2023. Employees are fully vested as soon as they receive the money, so any contribution becomes theirs immediately.
Who it may be best for: Better for businesses with at least a few employees and may allow companies to offer a lower total retirement benefit than other plans do.
Those three defined contribution plans are among the most popular, but the self-employed should also be aware that they can set up a defined benefit plan. A defined benefit plan can allow you to sock away even larger amounts on a tax-deferred basis, but they’re better suited to consistently higher-earning individuals.
“These are worthwhile to consider if your self-employment income is substantial,” says Dan Sudit, a partner at Crewe Advisors in Salt Lake City. “The contribution limit is based on a variety of factors including age, income, and years in business, but the annual benefit limit can exceed $200,000 a year.”
However, defined benefit plans can be more cumbersome to set up and generally cost more to maintain. But if you contribute enough, those costs may be worth the trade-off.
“In certain circumstances, depending on whether you make consistent contributions versus a large lump-sum contribution, it can be an effective tool in contributing substantially more dollars to your retirement savings than the other standard qualified retirement plans,” Sudit says.
For most individuals, a defined benefit plan is not really a worthwhile option, but that depends on your individual financial situation and especially your income.
What is a Good Retirement Plan For an Entrepreneur?
If the thought of being your own boss and directing your own profits makes your heart skip a beat, you may be destined to become an entrepreneur. Your job market experience or hampered professional successes may have made you realize that working for others is no longer the life you want. However, without the perks that corporate employment frequently provides, it can be difficult to find solutions to assist entrepreneurs in saving for retirement.
While entrepreneurship provides freedom and flexibility, it also has significant drawbacks. Paying for your own healthcare and investing for your own retirement are examples of problems. You no longer have the additional benefits that a full-time job provides. It is up to you to plan and save for your desired retirement lifestyle. If you believe that working for yourself is in your future, here are some ideas to help you save for retirement.
Open a Tax-Advantage Account
Even though you may no longer have access to a company-sponsored retirement plan, there are still plenty of options to help you save for your golden years. If you haven’t already, you should consider opening a tax-advantaged account. Here are a few options you can consider:
Traditional and Roth IRA
Traditional and Roth IRAs are both great retirement savings account options for entrepreneurs. Account holders can contribute to a traditional IRA with pre-tax dollars. It’s important to note, that traditional IRAs are tax deductible, while Roth IRAs are not.
In retirement, you must pay income tax on all traditional IRA distributions. However, Roth IRA distributions are tax-free. A contingency to note, with both IRAs you must be 59 ½ or older in order to take distributions without the 10% penalty.
As of 2019, you can contribute up to $6,000 in your IRA each year. If you’re 50 or older you can contribute an extra $1,000, making your total contribution limit $7,000. However, there are additional contribution limits for taxpayers who earn too much.
Simplified Employee Pension (SEP) IRA
If you’re a business owner who has few to no employees you may want to consider a SEP IRA. You can contribute up to $56,000 in 2019 or 25% of your net self-employment earnings. For reference, there’s a $280,000 compensation limit. Keep in mind, there are no Roth SEP IRAs and all distributions will require you to pay income taxes.
If you have employees, you must contribute an equal salary percentage for each one of your employees, including yourself. For example, if you contribute 4% of your salary to the account, you must contribute 4% of your employee’s salary to their account.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
If you have a larger business with up to 100 employees, a SIMPLE IRA is a good option for saving for retirement.
In 2019, you can contribute up to $13,000 with a makeup contribution of $3,000 for participants 50 or older. Employers can select to contribute a standard 2% as a non-elective contribution, or a 3% match contribution.
All contributions must not exceed $19,000. If you choose the 2% non-elective contribution, your employees do not have to participate in order to receive the contribution. All employee contributions are tax deductible. Keep in mind, that distributions taken in retirement are tax applicable, based on your tax bracket.
Also, contributions to employee accounts are tax deductible for the business owner as a business expense. Similar to most retirement plans, a 10% penalty applies to any distributions taken before you reach 59 ½. But, if you take a distribution within the first two years of participation in the plan, your penalty will increase to 25%.
One-Participant or Solo 401(k)
A solo 401(k) is a good retirement option for entrepreneurs with no employees. With this option, the account holder plays the dual role of employer and employee. Total contributions to the account cannot exceed $56,000 ($62,000 including catchup contributions for participants over 50).
Additionally, your total yearly earning amount is a consideration when determining your contribution limit. For 2019, the earning limitation is also $280,000.
Solo 401(k) plans work similarly to 401(k) plans in your ability to contribute with pre-tax dollars. Then in retirement, you will need to pay income tax on all distributions after age 59 ½. You can also decide to open a Roth solo 401(k) which mimics the tax treatment of the Roth IRA.
This account can be beneficial for those who are entrepreneurs and want to save a lot of money throughout their career, or only in a few years.
Establish Automatic Contributions
Automating your retirement savings is one of the best strategies to help entrepreneurs save for retirement. With the busy lives entrepreneurs lead, it’s easy to forget to contribute to their retirement savings. Automating their contributions can help entrepreneurs stay consistent and continue to allow their nest egg to grow over time.
After a while you won’t even miss the contribution amount. It will be as if you’re paying another bill. It may also be beneficial to increase your automatic contribution amount over time. Slowly increasing your contribution will let you ease into automation. It will ease the shock of a large contribution initially.
Diversify Your Portfolio
Many entrepreneurs use their business as a retirement planning option. They assume that when they retire, a worthy buyer will be ready to purchase their business for the exact amount they desire. Unfortunately, this perfect scenario may not come to fruition. That’s why it’s important for entrepreneurs to not only focus on building their businesses but also focus on building their retirement savings as well.
Diversification is an important element of retirement planning for entrepreneurs. Putting all their eggs in one basket, such as the anticipated sale of a business, can expose them to more risk than they may be willing to take. This situation is similar to an employee only purchasing company stock. If the company’s value decreases over time, it may not have enough savings to prosper in its golden years.
Including stocks, exchange-traded funds, bonds, real estate, and your business in your portfolio can help you minimize your risk and enable you to prosper in retirement. If you’re unsure how to diversify your retirement portfolio, partnering with a financial planner can help you determine the appropriate asset to reach your retirement goals.
The retirement plan that works best for you depends on your situation. While the solo 401(k) is generally a great pick, it’s a non-starter if you employ more than you and your spouse. So to pick the right plan, you’ll want to think carefully about your needs and where your business is going.
“Choosing the right one requires thoughtful planning, because if you rush or are sold on one strategy versus carefully considering your needs and circumstances, you may find yourself feeling short-changed and ill-prepared for your retirement,” Sudit says.