Retirement Strategies for Small Business Owners
As a small business owner, you are fully responsible for your own retirement planning. If you have employees, you may feel responsible for helping them plan a successful retirement. Considerations and retirement plan that work for you as a small business owner should be at the forefront of your mind when planning your own retirement and that of your employees.
Choosing a Traditional Retirement Strategy
In addition to using your small business to fund your retirement, there are some traditional options, such as IRAs and 401(k)s, that serve as additional sources of retirement income instead of liquidating your small business.
Creating a SIMPLE IRA
The SIMPLE IRA (Savings Incentive Match Plan for Employees) is a pension plan available for small businesses. In 2023, employees can defer up to $15,500 of their pre-tax salary (rising to $16,000 in 2024). Those 50 years of age or older may defer up to $19,000 by paying a catch-up contribution of $3,500.
The catch-up contribution remains at $3,500 in 2024, so employees aged 50 or older may defer a total of $19,500. However, employees participating in other employer-sponsored plans may not contribute more than $22,500 to all employer-sponsored plans (increasing to $23,000 in 2024).
Employers may increase employee contributions to a SIMPLE IRA by up to 3% of the employee’s salary. Conversely, employers may contribute 2% of each eligible employee’s salary up to $330,000 in 2023 (and up to $345,000 in 2024). Employer contributions are tax deductible.
Creation of a SEP IRA
The Simplified Employee Pension (SEP) is another type of individual retirement account (IRA) to which small business owners and their employees can contribute. In 2023, employees will be able to make pre-tax contributions of up to 25% of earnings or up to $66,000 (up to $69,000 starting in 2024), whichever is lower.
As with a SIMPLE plan, small business owners can make tax-deductible contributions for eligible employees, and employees pay no tax on the amounts the employer pays on their behalf until they receive distributions from the plan upon retirement.
Almost any small business can create a SEP. It does not matter how many employees you have or whether your company is structured as a sole proprietorship, partnership, corporation or not-for-profit entity. You can decide each year how much to contribute on behalf of your employees, so you do not have to rely on a contribution if your company has a bad year. Company owners are also considered employees and can make contributions to their accounts.
Overall, the SEP plan is the best option for many small businesses because it allows for higher contributions and more flexibility.
IRAs and individual 401(k) plans
If you operate in a competitive industry and want to attract top talent, you may need to offer a retirement plan like the two described above. However, employers are not required to offer retirement benefits to their employees. If you do not, you can save for your retirement without involving your employees through a Roth or traditional IRA, to which anyone with earned income can contribute.
You can also contribute to an IRA in your spouse’s name. With a Roth IRA, you can make after-tax contributions and receive tax-free distributions upon retirement; with a traditional IRA, you can make pre-tax contributions but must pay taxes on distributions. In 2023, the maximum contribution you can make to an IRA is $6,500, or $7,500 if you are age 50 or older. For the 2024 tax year, these limits increase to $7,000 and $8,000, respectively.
If your small business has no eligible employees other than your spouse, you can contribute to a 401(k) Only.
Developing an exit strategy for your company
It may seem strange that developing an exit strategy for your company is one of the first considerations when planning for retirement. But consider this: the small business you have built during your lifetime could become your greatest asset.
If you want to use it to finance your retirement and stop working, you will have to sell your investment. To prepare to sell your small business one day, you need to be able to operate it without you. It is never too early to start thinking about how to achieve this goal and find the best buyer for your small business.
Market conditions affect the ability to sell the business. You may want to create some flexibility in your pension plan so that you can sell your shares during a strong market or work longer during a recession.
In any case, you want to avoid a distress sale: if you wait until the last minute to exit the company, the problem is that your impending retirement will give the impression of a distress sale to potential buyers and you will not be able to sell the company at the highest price.
Why do small companies not offer 401(k)s?
Sometimes small businesses do not offer 401(k) funds because they simply do not have the resources to do so. The small business owner may not have the time or the knowledge to set up a pension fund for the company. Moreover, he or she may not have access to a trusted financial institution that can offer such a plan. Moreover, it may be too expensive for the company to set up a 401(k) plan.
Can you create a pension plan yourself?
Yes, it is possible to create a pension plan yourself. The easiest way is to set up a traditional or Roth IRA and make contributions. Depending on your specific situation, you can also open a Solo 401(k).
How much can you contribute to an IRA?
The amount you can contribute to an IRA (traditional or Roth) in 2023 is $6,500. The amount increases to $7,000 in 2024. In both years, if you are 50 or older, you can contribute an additional $1,000.
The bottom line
Many small business owners say they don’t want to retire, or at least not completely. But even if you are among the many small business owners who want to continue working, it is a good idea to set up a retirement plan for your small business because it gives you options and when you have options, you are happier with the path you choose.
