RETIREMENT PLANNING

Retirement Plan Options For Small Business Owners

By Martin A. Scott, CFP®, EA

Employees generally have access to a retirement plan from their employer but that is not the case for those who are small business owners (e.g., self-employed individuals). Small business owners must be proactive in creating their own retirement savings plan and not solely rely on the potential sale of their business in the future; the sale might not go as planned or yield a lower than anticipated sale price, which could negatively impact a retirement plan.

Operating a business requires much financial capital, so it can be challenging to allocate money to invest specifically for retirement. However, not properly addressing retirement planning can lead to adverse consequences in the long term. The good news is there are retirement plan options available for small business owners that provide tax advantages (e.g., tax-deferred investing) and flexibility.

Additionally, having the appropriate retirement plan in place can help small business owners attract and retain qualified employees if this is part of the long-term strategy of the business. This list does not include every potential option but I discuss three retirement plans that I think are most applicable: Simplified Employee Pension Plan (SEP), Solo 401(k), and SIMPLE IRA. 

Simplified Employee Pension Plan (SEP)

A Simplified Employee Pension Plan (SEP) is a retirement plan option that is advantageous to small business owners who have no (or a few) employees and fluctuating earnings. This type of plan allows small business owners to set up SEP IRAs for themselves and each of their employees (if applicable). Small business owners have discretion with the annual contribution amount to these SEP IRAs; contributions are not required every year. By not having an annual contribution requirement, the owner has significant flexibility, as they can decide on the appropriate amount to contribute based on the performance of their business in a specific year. Additionally, the low start-up/operating costs and simplicity of setup are attractive features of SEPs as well.

If an owner contributes to their own SEP IRA and has eligible employees, the owner must also contribute to each of the SEP IRAs of these employees. In this scenario, the owner would be required to contribute a uniform percentage of compensation for all plan participants (owner and employees).

For the 2024 tax year, contributions to a SEP IRA cannot exceed the lesser of 25% of compensation (amount of compensation taken into account is $345,000) or $69,000. Note that special rules apply for self-employed individuals when determining the compensation amount.

Solo 401(k)

A Solo 401(k) is a retirement plan option designed for small business owners who have no employees (other than a spouse). The primary feature of this type of plan is its high contribution limits, as contributions can be made as both the employer and an employee, which can substantially bolster retirement savings going forward.

For the 2024 tax year, aggregate contributions (as employer and employee) can get up to a maximum of $69,000 or $76,500 when including $7,500 catch-up contribution for those who are age 50 or older.

Note that if the plan balance is greater than $250,000, Form 5500-EZ—the Annual Return of a One-Participant (Owners/Partners and their Spouses) Retirement Plan—must be filed with the IRS.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement plan designed for small business owners who have 100 or fewer employees. Like a SEP, this type of plan is easy to set up and has low operating costs. For each eligible employee, a SIMPLE IRA must be set up. Owners are required to contribute to their employees’ accounts and employees can make their own contributions as well. Given that a SIMPLE IRA has mandatory contributions to employees from the owner, it does not have the same flexibility as a SEP, where contributions are discretionary. The required contributions to employees can be made by one of two methods: match employees’ contributions (dollar-for-dollar basis) up to a specific amount or nonelective contributions (requiring the owner to make contributions regardless of the amount the employee decides to contribute).

For the 2024 tax year, the contribution limits are noted below:

Note that self-employed individuals who have a SIMPLE IRA plan are treated as both the owner and an employee when calculating plan contributions and limits.

What’s Right For You?

Each of these retirement options will not be applicable or advisable for every small business owner. Some factors to consider when deciding on which is best for you include the cash flow of the business, long-term business goals, and number of employees. 

Martin A. Scott, CFP®, EA is the founder of Lasting Wealth Principles, a Fee-Only, financial and tax planning firm dedicated to helping small business owners. He can be contacted at martin@lwprinciples.com and (732) 995-5538.

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