Are you self employed? Do you have your own business? Determining how to choose the best small business retirement plan account is difficult. The best plan for you will depend on how much you want to save and how much you want to lower your tax bill. Small business owners are so busy running their businesses the last thing they want to think about is setting up a retirement account. The right plan (and the right amount of contributions) can set you up for financial success and save you money on taxes.
Thirty-four percent of entrepreneurs don’t currently have any retirement savings plan at all, according to a recent survey by Manta, an online community for small businesses. (For more, see: Top Retirement Strategies: Small Business Owners.)
Whether you are a super saver or just getting started it is important to pick the right retirement account for your business. Even if you love what you do and never plan to retire, a retirement plan can help you slash your tax bills today. At the very least you can plan for financial independence - the day at which work becomes an option. Or maybe you have a little more ease only taking on ideal clients.
You should strive to save between 10% and 20% of your income towards retirement. That may sound impossible to many of you. The important thing is to get started. So, I’m going to lay out the Goldie Locks three options for small, medium and large savers.
The Small Saver - Less Than $5,500
The Medium Saver - $5,500 to $54,000
If you are able to save in this range, you should consider a SEP IRA or Solo 401(k) plan. Both of these plans will allow you to stash away more money in a tax favored manor than a Roth or traditional IRA. Which plan is best for you will depend on a combination of how much you make and how much you want to save.
SEP IRA: This is the easier of the two accounts to set up and maintain. You may not be able to put as much money away into this type of account depending on your income. Generally, you can put away 25% of your adjusted gross income (after deductions, including your SEP contributions). This plan may not be great for big savers with smaller (net) incomes. (For more, see: 401(k) Plans for the Small-Business Owner.)
SEP for Procrastinators: The big advantage of a SEP IRA is that you can set it up and fund it for the prior year. For example, you get surprised with a big tax bill. You potentially have until October of the following year to set up and fund a SEP IRA. A 401(k) plan would have to be set up during the actual tax year.
Solo 401(k): You can potentially put away $18,000 as an employee of the business. Additional profit sharing contributions can take the total up to $54,000 of allowed tax-deductible contributions. More if you are over 50. Solo 401(k)s are also better for business partners as you have more flexibility to each contribute what is right for you.
The Large Saver - $54,000 or More
Looking to save more than $54,000 per year? Check out the defined benefit pension plan combined with a Solo 401(k). Take the benefits of a Solo 401(k) as described above and add a personal pension plan to the mix.
This is a program structured for small business owners or the self-employed and high earners. That is, those with just a few employees or who work as sole proprietors - generally around their 50s - who want to reduce their tax bills and will be socking away large amounts of money for retirement or maybe just to achieve financial independence.
The defined benefit pension plan is specifically for those who earn high enough incomes and can afford to put much more away than is allowed with just a 401(k) plan. Participants can deduct their contributions, resulting in large tax deferrals, while creating their own “personal” pensions. Much like the pension plans our parents or grandparents enjoyed, these will guarantee a set monthly payment in retirement through the rest of your life.
Personal defined benefit plan: Contributions are mostly based on a combination of your age and income. The younger you are, the less you can contribute. The reason is that if you are younger, the money saved will have more time to grow. In the past, I've set up plans for my clients so that they were able to contribute more than $200,000 per year for themselves (saving them over $100,000 in taxes by the way). This is potentially above and beyond what you can put into a 401(k) profit sharing plan. But you can do this too, if you maximize potential contributions and lower your tax bill in the current year, as well as tax deferral for the savings. (For more from this author, see: A Defined Benefit Plan for Small Business Owners.)