The old business model was: work, save, retire on a pension. These days, such a simplistic model is becoming increasingly rare in practice. The economic downturn flipped the focus for many small business owners from saving to mere survival. When the life of your business is on the line, retirement doesn’t just drop off the priority list: more than a few entrepreneurs found themselves tapping into those tax-free coffers early, absorbing the sting of early-withdrawal fees in order to stay afloat. Some see themselves living out their days on business profits, while others can’t picture themselves retiring at all. Still others are just scratching the entrepreneurial itch when they retire, funding self-employment ventures with the money they’ve amassed over the years.
If you’re within 5 years of opening your doors, retirement strategies for you and your employees might be the farthest thing from your mind right now. Offering a retirement savings plan can be costly for a small business owner, but it’s also a huge selling point for potential team members. I already have a savings account. Isn’t that good enough?
In the short term, the answer would be yes. It’s important to have money set aside for upcoming life events as well as unexpected emergencies. Long term, not really. You’ll get much more out of a tax-sheltered, interest-earning retirement account. Besides, employer contributions are tax-deductible. Each serves its purpose. Retirement accounts charge a hefty fee and back taxes for dipping in early, but you can still get to your money in a real pinch.
Here are some of the options:
A Savings Incentive Match Plan for Employees is an employer-provided pre-tax funded Independent Retirement Account (IRA) or 401(k). Like other plans, SIMPLE is funded mostly by pre-tax employee deferrals and partly by employer contributions. Employee contributions are optional up to the current yearly maximum of $11,500 or $14,000 for employees 50 and older, while the employer must match employee contributions up to 3% of their compensation.
The key advantage of a SIMPLE plan from a small business owner’s perspective is efficiency: ease of set-up, relatively low annual fees, and light administrative paperwork.
Simplified Employee Pension Plans are entirely employer-funded and tax-deferred to withdrawal. Employee contributions aren’t allowed. You must contribute the same amount to each employee’s account – up to 25% of compensation. As such, contribution limits rather high with a SEP Plan. The more employees you have, the more this number adds up, but you aren’t required to contribute every year. You don’t have to contribute at all, in fact, but if that’s the case, you should probably consider another plan.
The SEP’s key advantage is contribution flexibility: contribute when you’re able and focus your funds elsewhere when the chips are down.
More appropriate for companies with 20 or more employees, a traditional 401(k) has aspects of both plans previously mentioned. Employees can take pre-tax salary deferrals up to $17,500 or $22,000 for those 50 and over. Employers can contribute up to 25% of a team member’s compensation but are not required to do so. 401(k)’s typically have high administration fees in addition to requiring yearly tax filings and testing. This makes it less than ideal for extremely small businesses and the self-employed, but if your business can support it, the 401(k) has one of the highest contribution limits of any plan available.
Its key advantage is structural flexibility: contribute to your employees’ pension, let them build their own, or do both. Education programs are often available as an add-on to the plan to encourage employee participation.
For the very small businesses of just an owner and spouse, you can save too! Individuals are eligible for the SEP Plan and an individual 401(k) is available for self-employed or individual business owners with no employees. Why choose one over the other? The SEP IRA is simpler and cheaper, but the self-employed 401(k) allows for higher contribution limits. A Roth IRA is another option. While withdrawals from a Roth are actually tax-free, contributions are not tax-deductible, unlike other plans.