Being self-employed gives you a certain measure of freedom, but it doesn’t give you an excuse to skip out on saving for retirement. In fact, it makes putting money away that much more crucial: Unlike an employee who might have access to a 401(k), you’re on your own.

The first step: Figure out how much you need to save for retirement with a retirement calculator. The amount you plan to save each year will help determine the best account for you.

Second: Decide where to put that money. The good news is that flying solo gives you a lot of options. Let us discus this in full details.

• What are the Retirement Plan Options for Small Businesses?
• What are some ways a Business Owner can Minimize Taxes IRS?
• How much can you save on Taxes by Contributing to 401k?
• What is the best 401k for a Small Business?

What are the Retirement Plan Options for Small Businesses?

Traditional or Roth IRA

Best for: Those just starting out, or saving less than $6,000 a year. If you’re leaving a job to start a business, you can also roll your old 401(k) into an IRA.

Read Also: Should you Convert your Traditional IRA or 401(k) to a Roth IRA?

IRA contribution limit: Up to $6,000 in 2020, plus a $1,000 catch-up contribution for those 50 or older.

Tax advantage: Tax deduction on contributions to a traditional IRA; no immediate deduction for Roth IRA, but withdrawals in retirement are tax-free.

Employee element: None. These are individual plans. If you have employees, they can set up and contribute to their own IRAs.

How to get started: You can open an IRA at an online brokerage in a few minutes.

An IRA is probably the easiest way for self-employed people to start saving for retirement. There are no special filing requirements, and you can use it whether or not you have employees.

The toughest part might be deciding which type of IRA to open: We’ve given in-depth coverage to the differences between traditional and Roth IRAs, but the tax treatment of a Roth IRA might be ideal if it’s early days for your business. In that case, your tax rate is likely to be higher in retirement, when you’ll be able to pull that money out tax free.

One note: The Roth IRA has income limits for eligibility; those who earn too much can’t contribute.

Solo 401(k)

Best for: A business owner or self-employed person with no employees (except a spouse, if applicable).

Contribution limit: Up to $57,000 in 2020 (plus a $6,000 catch-up contribution for those 50 or older) or 100% of earned income, whichever is less. To help understand the contribution limits here, it helps to pretend you’re two people: An employer (of yourself) and an employee (also of yourself).

• In your capacity as the employee, you can contribute as you would to a standard employer-offered 401(k), with salary deferrals of up to 100% of your compensation or $19,500 (plus that $6,000 catch-up contribution, if eligible), whichever is less.
• In your capacity as the employer, you can make an additional contribution of up to 25% of compensation.
• There is a special rule for sole proprietors and single-member LLCs: You can contribute 25% of net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself.
• The limit on compensation that can be used to factor your contribution is $285,000 in 2020.

Tax advantage: This plan works just like a standard, employer-offered 401(k): You make contributions pre-tax, and distributions after age 59½ are taxed

Employee element: You can’t contribute to a solo 401(k) if you have employees. But you can hire your spouse so he or she can also contribute to the plan. Your spouse can contribute up to the standard employee 401(k) contribution limit, plus you can add in the employer contributions, for up to an additional $57,000 total, plus catch-up contribution, if eligible. This potentially doubles what you can save as a couple.

How to get started: You can open a solo 401(k) at many online brokers. You’ll need to file paperwork with the IRS each year once you have more than $250,000 in your account.

This plan, which the IRS calls a “one-participant 401(k),” is particularly attractive for those who can and want to save a great deal of money for retirement or those who want to save a lot in some years — say, when business is flush — and less in others.

Keep in mind that the contribution limits apply per person, not per plan — so if you also have outside employment that offers a 401(k), or your spouse does, the contribution limits cover both plans.

One other thing to know: You can also choose a solo Roth 401(k), which mimics the tax treatment of a Roth IRA. Again, you might go with this option if your income and tax rate are lower now than you expect them to be in retirement.

SEP IRA

Best for: Self-employed people or small-business owners with no or few employees.

Contribution limit: The lesser of $57,000 in 2020 ($56,000 in 2019) or up to 25% of compensation or net self-employment earnings, with a $285,000 limit on compensation that can be used to factor the contribution. Again, net self-employment income is net profit less half of your self-employment taxes paid and your SEP contribution. No catch-up contribution.

Tax advantage: You can deduct the lesser of your contributions or 25% of net self-employment earnings or compensation — limited to that $285,000 cap per employee in 2020 — on your tax return. Distributions in retirement are taxed as income. There is no Roth version of a SEP IRA.

Employee element: Employers must contribute an equal percentage of salary for each eligible employee, and you are counted as an employee. That means if you contribute 10% of your compensation for yourself, you must contribute 10% of each eligible employee’s compensation.

Get started: You can open a SEP IRA at many online brokers just as you would a traditional or Roth IRA, with a few extra pieces of paperwork.

A SEP IRA is easier than a solo 401(k) to maintain — there’s a low administrative burden with limited paperwork and no annual reporting to the IRS — and has similarly high contribution limits. Like the solo 401(k), SEP IRAs are flexible in that you do not have to contribute every year.

The downside for you, as the business owner, is that you have to make contributions for employees, and they must be equal — not in dollar amount, but as a percentage of pay — to the ones you make for yourself.

That can be costly if you have more than a few employees or if you’d like to put away a great deal for your own retirement. You cannot simply use a SEP to save for yourself; if you contribute for the year, you have to make contributions for all eligible employees.

SIMPLE IRA

Best for: Larger businesses, with up to 100 employees.

Contribution limit: Up to $13,500 in 2020 or $13,000 for 2019 (plus catch-up contribution of $3,000 if 50 or older). If you also contribute to an employer plan, the total of all contributions can’t exceed $19,500.

Tax advantage: Contributions are deductible, but distributions in retirement are taxed. Contributions made to employee accounts are deductible as a business expense.

Employee element: Unlike the SEP IRA, the contribution burden isn’t solely on you: Employees can contribute through salary deferral. But employers are generally required to make either matching contributions to employee accounts of up to 3% of employee compensation, or fixed contributions of 2% to every eligible employee.

Choosing the latter means the employee does not have to contribute to earn your contribution. The compensation limit for factoring contributions is $285,000 in 2020.

Get started: The process is similar to a SEP IRA — you can open a SIMPLE at an online broker, with a heavier paperwork load than your standard IRA.

If you’re the owner of a midsize company with fewer than 100 employees, the SIMPLE is a fairly good option, as it’s easy to set up and the accounts are owned by the employees.

SIMPLE IRA contribution limits are significantly lower than a SEP IRA or solo 401(k), however, and you may end up having to make mandatory contributions to employee accounts, which can be expensive if you have a large number of employees who participate.

The SIMPLE IRA is also inflexible, particularly early on: Early withdrawals, before age 59½, are treated the same as early 401(k) or IRA distributions, in that they are taxed as income and subject to 10% penalty.

But if you make a withdrawal within the first two years of participation in a SIMPLE IRA, the 10% penalty is increased to 25%. That means you also can’t roll over a SIMPLE to another retirement account within that two-year period. Zing.

One other thing to know: There is a 401(k) version of a SIMPLE, which works in much the same way but allows participants to take loans from their accounts. This version requires more administrative oversight and can be more expensive to set up.

Defined benefit plan

Best for: A self-employed person with no employees who has a high income and wants to save a lot for retirement on an ongoing basis.

Contribution limit: Calculated based on the benefit you’ll receive at retirement, your age and expected investment returns.

Tax advantage: Contributions are generally tax deductible, and distributions in retirement are taxed as income. An actuary must figure your deduction limit, which adds an administrative layer.

Employee benefit: If you have employees, you generally offer this plan to them and make contributions on their behalf.

Get started: Your options for brokerages are more limited than with the above accounts.

We often lament the decline of pension plans, and this is exactly that: If you’re self-employed, you can set up your own pension — a guaranteed stream of income — in retirement by using a defined benefit plan.

So why wouldn’t everyone do it? They’re expensive, with high setup and annual fees. If you have employees, that fee will likely go up, and you’ll need to contribute on their behalf. They carry a heavy administrative burden each year, and they require a commitment to fund the plan with a certain amount per year. If you need to change that amount, you’ll pay additional fees.

The upside is that you can stash a lot of cash in these, so if you’re fairly close to retirement, earning a high income that you know you’ll maintain and that allows you to save a significant amount per year — we’re talking $50,000 to $80,000 or more — you might consider using this plan to supercharge your savings efforts.

What are some ways a Business Owner can Minimize Taxes IRS?

Taxes can be stressful for a small business owner. You likely wear many hats, and the last thing you want to do is give more of your hard-earned business income to the government.

Thankfully, there are many tax savings strategies to reduce your taxable liability as a business owner. If you need ways to reduce your taxable income this year, consider some of the following methods below.

Employ a Family Member

One of the best ways to reduce taxes for your small business is by hiring a family member. The Internal Revenue Service (IRS) allows for a variety of options, all with the potential benefit of sheltering income from taxes. You can even hire your children.

According to Scott Goble, a certified public accountant (CPA) and founder of Sound Accounting, by hiring family members, “small business owners are able to pay a lower marginal rate, or eliminate the tax on the income paid to their children.”

For example, sole proprietorships do not need to pay social security and Medicare taxes on the wages of a child, nor the Federal Unemployment Tax Act (FUTA) tax. It is important to point out that earnings need to come from justifiable business purposes.

The IRS also allows small business owners the benefit of reducing their taxes by hiring a spouse, who would not be subject to the FUTA tax. Depending on the benefits they may have through another job, you may also be able to put aside retirement savings for them.

Start a Retirement Plan

As a small business owner, you give up a 401(k) match matched by an employer. However, there are several retirement account options that maximize retirement savings and reap valuable tax benefits. For example, with the one-participant 401(k) plan, the IRS allows you to put away up to $57,000 in total contributions for retirement. Some of those retirement planning vehicles include:

• Simplified Employee Pension Plan (SEP)
• IRA or a Roth IRA
• 403(b) plans

There are a variety of different retirement plan options for business owners on the IRS website as a tax savings strategy.

Save Money for Healthcare Needs

One of the best ways to reduce small business taxes is by putting aside money for healthcare needs. Medical costs continue to increase, and while you may be healthy now, saving money for unexpected or future healthcare needs is essential. You can accomplish this through a Health Savings Account(HSA) if you have an eligible high-deductible health plan.

“I also encourage every business owner to explore utilizing an HSA. As medical costs rise, many businesses look to lower the costs of health insurance,” says Sean Moore, CFP, ChFC of Smart College Funding. “By utilizing HSAs, the business and the employees can reduce taxes and potentially associated medical costs.”

Moore explains that the savings come in three key ways, otherwise known as the triple tax advantage: your contributions are pre-tax, they grow tax-free, and withdrawals for qualified medical expenses are tax-free.

Change Your Business Structure

As a small business owner, you don’t have the benefit of an employer paying a portion of your taxes. You’re on the hook for the entire amount of Social Security and Medicare taxes. If your business is taxed as a Limited Liability Company (LLC), you still have to pay those taxes, though in certain circumstances you may be able to eliminate the employer-half of those two tax responsibilities.

This might be a wise switch for some small businesses. While there are many things to consider in this switch, such as paying yourself a reasonable salary and other associated risks, it can be a good way to reduce your taxable responsibility.

Deduct Travel Expenses

If you travel a lot, you may be able to reduce your business taxes. Business travel is fully deductible, though personal travel does not enjoy the same benefit. However, to maximize your business travel, small business owners can combine personal travel with a justifiable business purpose. Any frequent flier miles earned from business travel can also be redeemed for personal travel later on.

How much can you save on Taxes by Contributing to 401k?

The 401(k) plan was created in 1986 to encourage employees of for-profit businesses to save for retirement. Two versions exist:

• The tax-deferred 401(k)
• And the Roth 401(k) introduced in 2006

Both retirement savings plans offer tax benefits and can help you build financial security for your retirement expenses, such as bills, food, and emergencies.

Tax-deferred 401(k)s reduce taxable income

Several variations of tax-deferred 401(k)s exist:

• The SIMPLE 401(k) for businesses employing fewer than 100 people
• The Safe Harbor 401(k), in which employees always own 100% of any money their employer contributes
• The traditional 401(k) popular with companies that have large workforces.
• Traditional tax-deferred 401(k)s used by self-employed savers without any employees are sometimes referred to as “Uni-ks” or “Solo Ks.”

With any tax-deferred 401(k), workers set aside part of their pay before federal and state income taxes are withheld. These plans save you taxes today: Money pulled from your take-home pay and put into a 401(k) lowers your taxable income so you pay less income tax.

For example, let’s assume your salary is $35,000 and your tax bracket is 25%.

• When you contribute 6% of your salary into a tax-deferred 401(k)— $2,100—your taxable income becomes $32,900.
  • $35,000 x 0.06 = $2,100
  • $35,000 – $2,100  = $32,900
• The income tax on $32,900 is $525 less than the tax on your full salary. So, not only do you get savings for retirement, you save on taxes today.

Tax-deferred interest with 401(k)s

When you put money into a bank savings account, you pay taxes on any interest it earns every year.  But, with a tax-deferred 401(k), you save taxes on the earnings of your contributions.

For example, if you contribute $100 a month into a traditional 401(k) that earns 8%, you could amass more than $150,000 of tax-free retirement savings over 30 years and save almost $50,000 in taxes as your earnings compounded.

Withdrawal timing to save taxes

Using a tax-deferred 401(k) does not mean you never pay taxes, however. Participants pay Uncle Sam when they withdraw their earnings and contributions.

As a retiree, your income often drops, putting you into a lower tax bracket than you had as an employee. Money you take from a tax-deferred 401(k) during retirement years therefore, gets taxed at a rate lower than what you pay while fully employed.

• Withdraw money early, though, and you pay taxes and a 10% penalty.
• The IRS lets you begin to withdraw without a penalty at age 59 1/2, and requires you to begin withdrawing by April 1 the year after you turn 72 or after age 70 1/2 if you attained this age prior January 1, 2020. However, required minimum distributions from 401(k)s and IRAs have been suspended for 2020.

Roth 401(k)s reduce post-retirement taxes

Like tax-deferred 401(k)s, earnings grow tax-free in a Roth 401(k). However, the IRS Roth earnings aren’t taxable if you keep them in the account until

• you’re 59 1/2 and
• you’ve had the account for five years.

Unlike a tax-deferred 401(k), contributions to a Roth 401(k) have no effect on your taxable income when they are subtracted from your paycheck. That’s because the funds are removed after taxes, not before. This means you are effectively paying taxes as you contribute, so you won’t have to pay taxes on the funds when you withdraw.

• Savers who believe their income during retirement will be low usually opt for a traditional 401(k).
• Those who predict they will have more income and fall under a higher tax bracket when they leave the workforce prefer the Roth 401(k).

Among other things, the tax savings you get with a Roth 401(k) depends on the difference between your tax rate while employed and your future tax rate during retirement. When your retirement tax rate is higher than your tax rate throughout your working years, you benefit tax-wise with a Roth 401(k) plan.

• Taxpayers have the option of funding both a Roth 401(k) and a tax-deferred 401(k).
• The IRS adjusts the maximum contribution amount to account for cost-of-living and announces the annual limits for each type of 401(k) at least a year in advance.
• Traditionally, the IRS has provided an additional contribution option for savers age 50 and older to enable them to prepare for their pending retirement – $6,500 in 2020.

Tax benefits for saving

Based on your income and filing status, your contributions to a qualified 401(k) may lower your tax bill more through the Saver’s Credit, formally called the Retirement Savings Contributions Credit.

• The saver’s credit directly reduces your taxable income by a percentage of the amount you put into your 401(k).
• Since its introduction in 2002, this credit for retirement savings has ranged from $1,000 to $2,000.
• Eligible taxpayers calculate their credit using form 8880 and enter the amount on their 1040 tax return.

What is the best 401k for a Small Business?

Historically, small employers have steered clear of offering 401(k) plans, seeing them as complicated to establish and costly to administer. The rules for running a plan properly are admittedly complex. But increasingly, 401(k) management companies are helping to make the task easier, by providing plans geared to the little guys of the business world.

If you are a small business owner considering initiating a 401(k) plan for your employees (and yourself), here are ten of the top retirement plan providers. They not only offer affordable plans but can act as administrators and investment fiduciaries—relieving you of the headache-inducing homework that comes with any plan.

ADP

ADP’s 401(k) plans offer investment options from more than 300 investment managers. Three investment line-ups are available for participants, based on their familiarity with investing and financial assets.

In addition to retirement plans, ADP specializes in payroll, tax filing, HR, insurance and administrative services. ADP’s small business division (1 to 49 employees) provides integration of payroll and recordkeeping with 401(k) plans, an important benefit for small employers.

Employees with existing 401(k) accounts have the option to transfer those plans into the new plan, and a mobile app lets employees check their retirement accounts from their smartphones and other devices.

American Funds

With more than 360,000 retirement plans overall, American Funds provides 401(k) account options that can be tailored to any size company, including startups and those that have recently merged or made acquisitions.

Their plans include both traditional and Roth versions. Investment choices can be objective-focused (preservation, balance, and growth) or individual mutual funds. 

Betterment for Business

A newer player, Betterment for Business started offering its 401(k) plans to smaller businesses in 2016.

As a robo-adviser, Betterment addresses many of the cost issues associated with the administration and management of a company 401(k) plan by using proprietary algorithms. In addition, Betterment says it eliminates fee hiding by using exchange-traded funds (ETFs). 

Charles Schwab Index Advantage

Schwab designed its Index Advantage 401(k) plan to “lower costs, simplify investing and help workers better prepare for retirement,” to quote the company literature. The key is in the title: The plan uses index mutual funds or exchange-traded funds (ETFs) with low operating expenses instead of actively managed mutual funds. Schwab claims operating expense savings by as much as 82%.

Plans have no annual fees and participants get full access to all of Charles Schwab’s brokerage and banking services, including an interest-bearing, FDIC-insured savings account through Schwab Bank.

Automatic enrollment is available and employees can get help or use a self-directed brokerage account.

Edward Jones

Edward Jones offers small employers a variety of options when it comes to investments in its 401(k) retirement plans. They include stocks, bonds, mutual funds, and government securities.

The company offers education and administrative support to both business owners and employees. After the plan is established, employees can review their accounts online or through mobile apps made available by Edward Jones. 

Employee Fiduciary

Employee Fiduciary comes out of the gate offering to let business owners compare their current providers’ 401(k) fees to Employee Fiduciary fees. And indeed, Employee Fiduciary has very low fees. It costs just $500 to start a new plan or $1,000 to convert an old one. Small employers pay $1,500 a year for up to 30 employees plus 0.08% of assets under management.

Employees have access to 377 mutual fund families (including Vanguard), all available ETFs and even a brokerage window through TD Ameritrade.

Despite its low fees, Employee Fiduciary offers all the services of a full-price provider: tax return forms, annual report summaries, and benefit statements.

Fidelity Investments

Fidelity Investments has consultants to help business owners select a plan and then, once the plan is established, provides access for employees and owners via the internet. The company also offers a mobile app that allows employees to monitor their individual accounts.

Employees can transfer old retirement accounts into their new 401(k). Fidelity provides integration with payroll services, an advantage for small-business owners, as well as the full roster of services (plan administration, record-keeping, trading, and investment advisory).

Merrill Edge

Merrill Edge lists streamlining, convenience and affordability as key advantages to its small business 401(k) plan. Also included are the usual benefits—tax deductions for the employer, investment fiduciary support, and educational support for employees.

With an annual asset-based fee of 0.52%, Merrill boasts pricing that is lower than many competitors. Its plan includes online account management—a common feature in most 401(k) plans. An automatic enrollment option, as well as a Roth 401(k) option, are also available. Employers have the flexibility to contribute on a year-to-year basis.

ShareBuilder 401(k)

ShareBuilder 401(k) has retirement plans specifically designed for small employers. There are four different 401(k) options—individual, simplified, customized, and tiered profit sharing.

Each plan has distinct matching, vesting, and profit-sharing options and once the plans are established, employees are able to transfer existing retirement accounts into their new 401(k) account. In addition, ShareBuilder retirement plans integrate with the majority of payroll providers. 

T. Rowe Price

Advertising its small business 401(k) plans as appropriate for companies with fewer than 1,000 employees, T. Rowe Price says it offers a “cost-effective structure” for both sponsors and participants.

Read Also: Investing for Retirement: The Complete Guide

Investment options include a range of T. Rowe Price and non-T. Rowe Price investments. There is a plan sponsor resource center as well as 24/7 website access for participants. Sponsors may select from more than 100 no-load mutual funds and common trusts as well as over 5,400 non-proprietary funds. 

Of course, nothing replaces due diligence and good old-fashioned homework when it comes to checking out various 401(k) plan providers. Make sure you ask enough questions and more important, the right questions when considering a 401(k) plan for yourself and your employees.

Finally

With wise planning, you can reduce your taxable income as a small business owner and keep more of your money working for you. Just remember to consult a tax professional to make sure you qualify for the potential savings discussed here.