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A Guide to Small Business Retirement Plans


Running a small business or being self-employed can offer flexibility, freedom and control over your earning potential. While the perks are plentiful, there’s one thing that’s usually missing when you own a small business: an employer-sponsored retirement plan. Self-employed people don’t have 401(k)s, and small business owners tend not offer them, citing the time and cost to set up and administer them. The good news is there are several other retirement plan options available to small business owners. If you have yet to begin saving for retirement as an entrepreneur, here’s how you can change that. Consider working with a financial advisor as you plan for retirement.

Small Business Retirement Plan Basics

Before digging into the particulars of individual savings options it’s important to understand a few guidelines that govern small business retirement plans. For instance, each plan has its own annual contribution limit, just the way an employer’s retirement plan does. The amount you can contribute varies by plan, and a special limit may apply if you’re considered to be self-employed, rather than a business owner.

Next, each plan has its own tax rules to follow with regard to when you can take distributions, how those distributions are taxed and what can trigger a 10% early withdrawal penalty. Some plans also have special rules that apply to businesses that have employees.

Finally, small business retirement plans can offer tax advantages to savers. Your retirement savings can grow on a tax-deferred basis, earning compound interest over time. And some or all of your annual contributions may be tax-deductible, which could reduce your tax bill when you file your yearly return.

Small Business Retirement Plans: What Are the Options?

Here's a guide to small business retirement plans.

There are several ways to save for retirement as a small business owner. Here’s how three of the most popular options compare:

1. Simplified Employee Pension Plan (SEP IRA)

A SEP IRA can be established by any sized business, including sole proprietorships, partnerships and corporations. You can set up one of these accounts for yourself or on behalf of your employees. If you establish a SEP IRA for your employees, only you as the employer can make contributions to it, on their behalf; they’re not allowed to put anything in directly.

The annual contribution limit for a SEP IRA in 2022 is 25% of the employee’s annual compensation or $61,000, whichever is less; in 2023 the limit is 25% of the employee’s annual compensation or $66,000, whichever is less. There is no catch-up contribution for SEP accounts.

The IRS doesn’t allow loans from SEP IRAs, but employees and business owners can take in-service distributions. Contributions are always 100% vested. If distributions are non-qualified then income tax applies. The 10% early withdrawal penalty also kicks in if the person taking the distribution is under age 59 1/2.

On the pro side, a SEP IRA is relatively easy and inexpensive for small business owners to set up. The annual contribution limits mirror the limits allowed by traditional 401(k) plans. Contributions can be deducted from income and qualified distributions are taxed according to traditional IRA rules.

You’re not obligated to contribute to a SEP IRA for yourself or your employees each year. But if you do decide to contribute on behalf of your employees, you have to make a contribution for everyone who worked for you for the year.

2. Savings Incentive Plan for Employees (SIMPLE IRA)

Small business owner discussing retirement plan with employees

A SIMPLE IRA is available to any small business, but according to the IRS it’s generally best suited to those with 100 employees or fewer. With this plan, the employer is required to contribute money each year for each employee by either matching up to 3% of compensation or making a 2% nonelective contribution. Employees can contribute but aren’t required to and they’re always 100% vested in their SIMPLE IRA money. For 2022, the maximum employees can contribute is $14,000; for 2023 the limit is $15,500. Additionally, the catch-up contribution limit for 2022 is $3,000; the catch-up contribution limit for 2023 is $3,500.

Like SEP IRAs, SIMPLE IRAs have the same tax treatment as traditional IRA accounts. Early distributions are subject to the early withdrawal penalty and income tax; regular retirement distributions after age 59 1/2 are taxed at ordinary income tax rates only. Both SEP IRAs and SIMPLE IRAs require the account owner to begin taking required minimum distributions at age 70 1/2 to avoid a tax penalty.

SIMPLE IRAs are easy to set up and maintain. But they have lower annual contribution limits than SEP IRAs or solo 401(k)s (the next option on this list). You also don’t have the option to not make contributions for your employees with a SIMPLE IRA. This could be problematic if your cash flow is irregular from year to year.

3. Solo or Individual 401(k)

A solo 401(k) is a 401(k) that’s designed just for sole proprietors. (The only exception is if you own a business and your only employee is your spouse.) With this type of small business retirement plan, you make contributions as the employer and the employee. As the employee, you can contribute up to $20,000 for 2022, or up to $22,500 if you’re 50 or older. Limits on catch-up contributions for 2022 are $6,500 and $7,500 for  2023.

As the employer, you can contribute up to 25% of compensation, unless you’re self-employed. In that case, you have to use a special formula to calculate your employer contribution for the year. The formula is based on your net earnings after you’ve deducted one-half of your self-employment tax and your employee contributions.

Of all three small business retirement plans discussed so far, a solo 401(k) is the most difficult to set up and the most expensive to maintain. But you get the benefit of a tax deduction for your contributions, as well as generous annual contribution limits. You could also supplement your 401(k) with contributions to an IRA.

Are There Other Ways Small Business Owners Can Save for Retirement?

If you don’t have any employees or you don’t have enough business income to justify the expense and time involved in setting up a SEP IRA, SIMPLE IRA or individual 401(k), you could opt for a traditional or Roth IRA instead. With a traditional IRA, you may be able to deduct part or all of your annual contributions. A Roth IRA allows for 100% tax-free distributions in retirement.

A SIMPLE IRA has an annual contribution limit in 2022 of $14,000 and for those 50 or older they can make an additional catch-up contribution of $3,000. For 2023 the limits are $15,500 and $3,500, respectively. The total salary reduction contributions that an employee can make to all the plans he or she participates in is limited to $20,500 in 2022 and $22,500 in 2023.

Both traditional and Roth IRAs have an annual contribution limit of $6,000 for 2022, plus a catch-up contribution of $1,000 if you’re 50 or older. For 2023 the limit is $6,500 plus a catch-up contribution of $1,000 if you’re 50 or older.The limit is much lower compared to other retirement plan options for small business, but an IRA could be a good place to start if you’re new to saving.

The Bottom Line

There’s a lot to consider when choosing a retirement plan as a small business owner. If you have employees, you’ll need to decide if your plan will cover them as well as yourself. You’ll have to weigh the flexibility that a SEP IRA can offer against the rules for SIMPLE IRA contributions as well. If you’re a sole proprietor, the plan you choose may depend on how much you’re able to contribute each year from your income and what you’re willing to pay to manage the plan.

Whatever you decide, remember that there’s no better time to start saving for retirement than now. The longer you wait to choose a retirement plan for your small business, the less time your money has to grow.

Tips for Retirement Planning

  • A financial advisor can be a great partner in retirement planning, helping you nail down your retirement timeline and building an investing plan to get you there. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now
  • Take time to consider how much money you’ll need to retire comfortably. A retirement calculator can help you pin down how much you need to retire and how much you need to save to get you there.

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