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The Small Business Owner’s Simple Guide To Choosing A Retirement Plan

Steve Pomeranz, Small Business Owner, Guide To Retirement

Retirement Accounts For Small Business Owners

I recently received an email from a longtime listener who asked me: “Hey, Steve, any chance you could do a segment about your suggestions for retirement accounts for sole proprietors like me? I have and know all about Roth IRA’s but what about SEP accounts? What are the requirements and who can have a SEP?”

Well, Jill, of course, I can help you, so here goes! I am going to keep it simple and straightforward, so while I might leave out some of the specifics on air, you’ll get enough ideas of what you should do, and I’ll provide the resources on my website so you can venture into it even further if you want.

There are a variety of tax-favorable savings plans small business owners that should consider—plans whose main function is to help you save for retirement and reduce tax liability during your peak earning years.  Most of these plans feature minimal cost or administrative time commitment; however, the plan type will need to be considered carefully based on your current situation and how the plan can grow with your business.  Keep in mind that costs may vary dramatically when considering between a full commission broker, an insurance company, a low-cost brokerage firm or fiduciary investment advisor.

Traditional Vs. Roth IRA

You mentioned that you had a Roth IRA, but I’ll talk through some of the facts on the Roth and traditional IRA which are the most common and easiest plans.  I would venture a guess that most listeners are familiar with the basics of a traditional IRA and Roth, so I’ll make it quick.   Consider using one or both of these types of IRA if your contributions will total less than $11k annually—that is $5,500 each to the Roth and traditional IRA.  For individuals over 50-years-old, the limits move up to $6500 each or $13k total.  Some small business owners employ their spouse as well.  Doing so would allow you to each contribute, effectively doubling the limits.  For couples over 50-years-old, this would mean you could contribute a total of $26k annually.  Unfortunately, both the Roth and traditional IRA are subject to income limits that may prevent you from using them if you’re a higher earning business owner.

For more information, click here.

Save Up To $55K With A SEP IRA

You asked specifically about the SEP, so here goes.

The SEP IRA plan allows for the largest tax-deductible contributions which are made from the employer. Obviously, if you are a sole proprietor and you are the only employee, the employer (you) can contribute to the employee (you) and get the full deduction.

Remember that a SEP is a pension, so all the contributions come from the employer’s pocket. Another good thing is that the contribution is entirely voluntary. The employer is not required to make contributions (like if you have a soft year) but may contribute up to 25% of each employee’s income, and must do so uniformly for all eligible employees.  The limit is $55k annually, so if you can afford it and don’t mind contributing to your employees, you can get a nice juicy deduction and some powerful savings compounding over time.  Again, the SEP is particularly useful for high-earning self-employed individuals and 1099 contractors such as physicians, musicians, and others who have no other employees and don’t foresee hiring any.

Easy-To-Administer Simple IRA

Next, let’s look at the simple IRA. This plan is very similar to a 401k plan.  As the name implies, it is extremely simple to administer and has very low operating costs.  However, any contributions become the possession of the employee immediately and have certain employer contribution rules that may not be a good fit for larger employers.

The simple IRA is most frequently used by companies with between 1 and 25 employees.  The essentials are that the employee may elect contributions up to $12,500 ($15,500 for individuals over 50).  The employer must choose to contribute 2% of pay for all employees or match the first 3% of contributions dollar-for-dollar.  While the contribution limits are much lower than the SEP, the amount the employer has to contribute to employees is much lower with this simple IRA plan, possibly making it more attractive to businesses with a few employees.

Relatively Straightforward 401k Plans

Solo 401k: This plan goes by many names like individual 401k, one-participant 401k, uni-k, and self-employed 401k.  It works just like a 401k at a large company, but it is designed for sole proprietors who have no employees. The business owner wears two hats in this 401(k) plan: employee and employer.   So, the business owner may contribute up to $18,500 as an employee and up to 25% of earned income after that. Add them together and that gets you to a total combined contribution limit of $55k for 2018.  If you can include your spouse and are over 50, you could theoretically contribute up to $122,000 annually, making this one of the more attractive options for high earners.

Here’s another idea: A Safe Harbor 401k: This plan is like a hybrid between a simple IRA and full 401k plan.  It provides some of the benefits of a higher contribution limit ($55k in 2018) while avoiding much of the administrative burden.  The words safe harbor mean that you will be required to contribute a set percentage to your employees (3%) and, by doing so, you won’t have to bear the heavy reporting and administrative requirements to make sure the plan is fair to all employees.

There are a few more plan types which are worth considering, but they get a little too complicated to describe in a radio setting.

Profit-Sharing Plans Reward Employee Loyalty

However, here are two of them:

Profit Sharing Plan:  This allows flexible contributions, 25% up to $55,000. It also allows you to set up a vesting schedule for your employees, meaning they don’t get the money you’ve contributed until they perform so many years of service, no more than 6 years. This helps keep employees longer because they have to stay in order to earn it, and it protects you from making contributions to employees that don’t stick around long enough.

The profit sharing has to be administered, usually by a third party, so you may have higher third-party costs.

Defined Benefit: This type of plan can allow you to make a whopping tax-deductible contribution of up to $220,000.  The amount of contribution is based on a formula that calculates the amount of money you will need at retirement based on income need, your current age, and assumed rate of return. It can be especially useful for a sole employer 50-years-old and above who has younger employees. Younger employees will receive less annual benefit because they have so many more years for them to accumulate the target amount of money calculated to pay them a certain amount of income at retirement. The older contributor has fewer years, so the formula enables you to contribute a heck of a lot more.

This type of plan, as you can imagine, needs some fairly heavy third-party number crunching, so some administrative costs may be higher.

Getting Started

Okay, so how do you set these things up?

It’s quite simple. First, find a brokerage firm, investment advisor, or insurance company to work with. Look for an experienced person to help guide you toward the right solution.

I also recommend this link for an even deeper look: Click Here.

Well, Jill, I hope this helped.

And to everyone else, don’t forget to go to stevepomeranz.com and contact us with any question you may have and sign up for our show’s weekly update. Also, join our podcast, just search for The Steve Pomeranz Show in your podcast App.

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