The retirement guide you didn’t know you needed (if you own a business)
Everything you need to know when setting up your retirement plan
Most of my clients are self-employed and banking on their business to fund their retirement.
That said, almost all of them also contribute to tax qualified retirement accounts.
Why?
The money they contribute is tax deductible (it saves them money on taxes).
The money they contribute grows tax deferred (you never get a 1099 claiming that you owe tax on interest income, capital gains, or dividends).
And the money they contribute will supplement or provide for their retirement income (if unfortunately they’re unable to sell their business).
Here’s all the things they needed to know when getting set up:
How much money will they contribute?
Determining your anticipated contribution level first, can save you thousands in unnecessary admin fees.
Electing to establish a Solo 401k, which can cost you hundreds to thousands in set up costs, when you only intend to contribute a few thousand dollars does not make sense – you’ll pay more to your 401k provider than what you’ll ultimately save in taxes.
Often, I advise clients the following:
If you intend to contribute $7000 or less, then you should do a Traditional (or Roth) IRA.
If you intend to contribute $66,000 or less, then you should do a Solo 401k (or SEP IRA in some cases).
If you intend to contribute anything over $66,000 then we need to look at a Cash Balance Pension Plan (if eligible) or Non-Qualified Deferred Comp plans.
Do they have eligible w2 employees?
Pretty much any retirement plan you establish needs to also include some benefit for your employees (if you are a solo practitioner or just contract everything out then you don’t need to worry about this).
A SEP IRA for example, forces business owners to make equally proportional contributions to both their own and their employees retirement plans.
Therefore, if you have a SEP and intend on contributing 20% of your income into the account, then you also need to make 20% contributions into your employee’s accounts.
So, if you make $200k and contribute $40k, then your employee earning $100k will need to receive a $20k non-elective contribution (from your business’ pocketbook).
For this reason, a SEP probably isn’t the best idea if you have eligible w2’s. Here’s a simple framework for determining the best option:
If you have zero w2 employees (or your w2 employee is your spouse) then open a SEP IRA (or Solo 401k).
If you have several w2 employees that work FT/PT, are at least 21, and have been with you for three years then open a 401k plan.
Are fees an issue?
401k plans are great as they offer the most flexibility around funding and they even provide higher income earners (that would be otherwise ineligible) with the ability to make Roth contributions.
They suck because they cost more and require more paperwork.
For our clients that want simpler and cheaper retirement solutions SEP and Simple IRA’s have been great alternatives.
While they may be more limited/restricted in scope (SEP’s aren’t the best for larger businesses, and you can’t get as much money into a Simple), it usually costs nothing to set them up and you avoid the annual filings associated with a 401k plan.
Cheers