As a business owner, you won’t have access to a 401(k) plan the way most employees do. Since you’re the employer, you’re the one who has to take the initiative in setting up your own retirement accounts. Fortunately, you have many options to choose from.
Defined Benefit vs. Defined Contribution
First, you should learn which broad types of investment vehicles are available. The two main categories you’ll need to consider first are defined benefit (DB) plans and defined contribution (DC) plans.
Defined benefit plans are retirement accounts that guarantee a fixed payout for employees who meet certain conditions, such as working for a set number of years (for example, a traditional pension plan). These tend to be less popular among employers because of higher costs, but they also have higher contribution ceilings and a ton of tax advantages.
Defined contribution plans are more popular, and include plans like 401(k)s and IRAs. These are plans that require employees to contribute their own money, though they may also include a company match.
In these plans, employees have the option to invest their funds how they choose. Consumers have a couple of choices of ‘advisors’. Many are now gravitating to robo-advisors. However for our USA residents only here’s some information from CGTrust on why consumers should prefer traditional wealth managers.
Options for Small Business Owners
If you choose to go with a defined benefit plan, you’ll need to do some setup on your own.
Among defined contribution plans, you’ll have several key options, based on the nature of your business, how many employees you have, and how you prefer to plan for retirement.
- A Simplified Employee Pension Plan (SEP IRA). The SEP IRA is for self-employed people and for business owners with (almost) any number of employees. It’s relatively easy to set up and maintain, and you won’t owe a setup fee of an annual maintenance fee (in most cases). The employer is the only party that makes contributions in this plan, contributing up to 25 percent of any eligible employee compensation they choose, up to $55,000 per year.
- A Savings Incentive Match Plan for Employees (SIMPLE IRA). The SIMPLE IRA Is for companies with 100 or fewer employees, as long as there’s no other retirement program in place. The main advantage here is that employee contributions will be automatically withdrawn from paychecks, with a company match for contributions up to a certain percentage of the employee’s salary. There’s typically a setup and ongoing management fee to correspond with this type of plan. Both the employer and employee make contributions, and those contributions are pre-tax, which means withdrawals are taxed like regular income.
- A traditional 401(k). The traditional 401(k) is one of the most popular retirement plans, but because it can be complex to set up, it’s often better suited for mid- to large-sized businesses. Like the SIMPLE IRA, 401(k) contributions are automatically withdrawn from employee paychecks, but a company match is optional. Again, these contributions are taken pre-tax, which means you and your employees will owe taxes from your eventual withdrawals as if it were normal income. Annual contribution limits are capped at $18,500 as of the writing of this article.
- A self-employed 401(k). If you’re self-employed, you also have the option to create a modified version of a 401(k) for yourself. Here, contributors are allowed to contribute up to 25 percent of their eligible compensation, up to $55,000 per year, and up to $18,500 in salary deferrals, like with a traditional 401(k). Typically, the self-employed 401(k) plan is simpler to set up than a full 401(k) plan.
You don’t necessarily have to plan for your retirement through your business (though it is advantageous). You could also use one of the following investment vehicles:
- A traditional IRA. Anyone younger than age 70 ½ can contribute to a traditional IRA. Depending on whether you already have a retirement vehicle set up, you may be eligible to deduct the amount you contribute to this plan, making it pre-tax. You won’t be able to withdraw from this account until you’re 59 ½.
- A Roth IRA. A Roth IRA is similar to a traditional IRA in that anyone can contribute to it, but there are no age limits here. There are no deductions available for your contributions—the advantage here is that you won’t pay any taxes on the money when you withdraw it, meaning you won’t pay taxes on the growth you achieve. The maximum annual contribution for individuals under the age of 50 is $5,500.
No matter which retirement option(s) you choose as a business owner, you’ll need to invest your money wisely if you want to achieve optimal growth over time.
Depending on your investment time horizon (i.e., when you plan to retire), that could mean a higher-risk, higher-reward mix of stocks, or a lower-risk, lower-reward mix of stocks, ETFs, bonds, and other assets, like real estate. Do some research, and make sure to diversify your portfolio, no matter what.