Plan Your Retirement
When you’re self-employed, you have to be your own HR department. This includes looking for the right set of benefits to offer yourself (and your employees). It’s easy to overlook retirement plans. But not only will it save you in the long-run but in the short-term as well.
Several different retirement plans are catered to small business. They are straightforward to set up also also easy to manage. The right one for you depends on your business structure and the offering you want to provide to your employees. Below are some common options for self-employed individuals and small business owners.
Solo 401k
It’s definitely worth looking into a Solo 401(k) if you are the only employee in your company. As of 2018, you can defer up to $18,500 of your salary as a contribution to your 401(k). These are pre-tax dollars so it will reduce your federal tax liability in the short-term. (The federal government will tax you when you withdraw from your 401(k).) The only real requirement is that you have no employees.
The one-participant 401(k) plan isn’t a new type of 401(k) plan. It’s a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse. These plans have the same rules and requirements as any other 401(k) plan. – IRS website
As the employer, you can contribute to your Solo 401(k) as well! In total, the maximum contribution (employer contribution + employee deferred salary) is $55,000 — more if you are 50+ years old. The employer contribution is also tax deductible.
Another big benefit of a Solo 401(k) is how flexible it is. There’s no requirement for matching or contributions. If your business income isn’t stable yet or if your work/life balance changes, you can contribute more when you have a strong year and not contribute anything at all in leaner times.
Solo 401(k) contribution limits are generally the highest among the many options for retirement plans.
SEP IRA
This is an option that’s fairly straightforward because only the employer can contribute. This means you don’t have to calculate or track maximum employee contributions. You also don’t have to worry about setting matching rules for employee contributions. The SEP IRA is a traditional IRA used as a pension package. In fact, SEP stands for Simplified Employee Pension. There’s one key advantage over the traditional and even Roth IRAs and that is the contribution limit is actually higher — $55,000 or 25% of annual salary (whichever is lesser) as of 2018.
A Simplified Employee Pension (SEP) plan provides business owners with a simplified method to contribute toward their employees’ retirement as well as their own retirement savings. Contributions are made to an Individual Retirement Account or Annuity (IRA) set up for each plan participant (a SEP-IRA). – IRS Website
There’s also quite a bit of flexibility with this plan. You, as the employer, are not obligated to contribute in years where you can’t afford to. However, if you do contribute, you must do so for all employees who are eligible. That is, if your policy is to contribute 5% of an employee’s annual salary, you have to apply that consistently to all qualified employees — yourself included.
Simple IRA
If you have a small firm (around 10 employees), a SIMPLE IRA might be a great choice. Not only is it an attractive benefit to your employees, it can ultimately cost you less than paying higher wages (which you’d have to pay the employer portion of medicare and social security tax). It’s also a plan that employees coming from larger companies may be more familiar with. Your employees (yourself included) can contribute up to $12,500 (as long as they aren’t contributing to any other retirement plans).
A SIMPLE IRA plan (Savings Incentive Match PLan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan. – IRS Website
Employer matching is mandatory under this plan. You will also need to consistently apply the matching policy to all employees who qualify. Your options are to match dollar-for-dollar the employee’s deferred salary contribution (up to 3% of their salary) OR contribute a flat 2% of the employee salary (regardless of what the employee contributes). It’s a bit more to track employee contributions to do the dollar-for-dollar matching. In addition, you won’t know exactly how much the employer matching will be until your employees have made their salary deferral election. On the flip side, contributing a flat 2% gives you a predictable expense, easier to track & calculate, and is simpler to manage.
There are some options for lowering the matching limit down to 1%. However, there are strict guidelines for how, when and how often you can exercise this option.
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If you’re still gainfully employed and contributing to a retirement plan, you may already be maxed out on allowable contributions. For example, contribution limits for 401(k) plans are across ALL 401(k) plans and from all employers. If you are contributing to a 401(k) plan offered by your day job employer, that will impact your contribution limit from your business.
The same may be true of IRA accounts. If you have maxed out your 401(k) contributions, it’s possible you can’t contribute anymore to an IRA.
In most cases, with a SEP IRA though, you can still participate in your day job’s retirement plan while still contributing to your self-employment SEP plan.
Tax Benefits
Employer contributions to retirement plans are tax deductible. In addition, you don’t pay FICA and FUTA on contributions like you would on employee gross wages. So, if you can’t pay top wages, consider offering attractive/generous retirement packages. It will save you on employment taxes as well as lower your business’s NET income (saving you federal income tax too!). It’s possible a generous retirement benefit will not only save a lot while but also offer an attractive benefit to your employees.
Keep in mind, employee contributions are pre-tax dollars. That means employees who contribute through salary deferral will see lower taxes now. However, when they take distributions from their account, they will pay federal income tax at that time. Employees still owe their portion of FICA on their salary (including the deferred contributed to their retirement plan).
Conclusion
It’s well worth it to look into retirement plans for your business even if you’re a single-employee business. Whether you are just starting or you’re a well-established business, there’s a lot to gain. Not only will you be securing your retirement but you may even enjoy tax benefits now. If the choices have your head spinning, consult with your CPA so you can make the right choice for yourself and for your business as it grows.