Small business owners are actively involved in all aspects of the business, from day-to-day operations to continuing the sustainability and the growth of the business. At what point are you casting your net too wide?
It is not uncommon for business owners to assume they will never retire. After all, you’re doing what you love, so why not continue indefinitely? According to a Manta survey, a third of small business owners and entrepreneurs do not have a retirement strategy in place. Some entrepreneurs believe that selling their business is an effective way to fund their retirement. Attempting an exit strategy without a well-developed succession plan is not a feasible option. Small business owners must plan for themselves because if they don’t, who will?
Before we begin reviewing the different retirement plan options, we need to determine the objective that we would like the retirement plan to achieve. Are we trying to maximize tax deductions? Would we like the plan to be used as an incentive to attract and retain our employees? Are we interested in a plan that allows for flexibility with the employer contributions? There are a multitude of factors that need to be considered before selecting the appropriate retirement plan. Retirement planning is complicated when it involves only yourself, but it becomes more so when safeguarding your employees’ retirement. There are retirement plans that are specifically designed for small businesses; do you know which one could be best utilized by your business? Here are the salient points of several plans:
Savings Incentive Match Plan for Employees (Simple IRA)
The amount an employee contributes from their salary cannot exceed $13,000. The employer is generally required to match each employee’s salary reduction contributions on a dollar-for-dollar basis up to 3 percent of the employees’ compensation. Employer contributions to the plan are tax deductible. If permitted by the plan, employees who are age 50 or older at the end of the calendar year, can make catch-up contributions of $3,000. If a member of the plan makes an unqualified withdrawal before you are 59 ½ years old there will be a 10 percent penalty. Keep in mind if withdrawals are made within the first two years of participation in the plan the penalty increases to 25 percent. This retirement plan is an easy plan to administer and is affordable, which makes it a great starter plan.
Simplified Employee Pension Plan (SEP-IRA)
Only the employer is permitted to make contributions to this plan. The employer has the option to contribute to each eligible employee account each year, but the amount cannot exceed $56,000 or 25 percent of the employees’ compensation. Keep in mind if the business owner contributes to their SEP-IRA, then contributions will be required for all eligible employees in the same proportionate manner. Contributions made to eligible employees are tax deductible to the firm. Since the contributions are funded by the employer. the catch-up provision will not apply. The 10 percent penalty will apply on unqualified withdrawals made before the age of 59 ½. If the businesses profits vary year to year, then you will want to consider this plan since it allows for flexibility and control over the employer contributions.
This is a special savings option for small business owners who don’t have any employees (except for a spouse or business partner/s) since it allows for contributions by both the employee and employer. This means that you would be able to contribute $19,000, as the employee. Then as the employer, you can contribute up to 25 percent of your compensation for the year, with a maximum of $55,000 in combined contributions (employee + employer contributions) each year. If you are 50 years old, then your combined contribution with the catch-up provision could not exceed $61,000. Take note that once the plan assets exceed $250,000, you will need to file an annual 5500 tax form. This plan is an attractive option for a small business owner that would like to aggressively fund their retirement.
I have covered only the basic retirement plan options that can be administered by small businesses. The process of determining the best retirement plan and exit strategy for your business involves comprehensive planning. As a CERTIFIED FINANCIAL PLANNER™ Professional, I enjoy assisting clients with simplifying all of life’s complexities. We at Coral Gables Trust Company look forward to leading you on the path to living your best financial life.