Choosing a Small Business Retirement Plan? Consider These 6 Things First

Did you start your business to improve your financial security? You’re not alone – according to Entrepreneur Magazine, about two-thirds of US small business owners say they were motivated to start a company to have better financial stability.  

Part of financial stability is personal wealth. For that, a small business retirement plan should be near the top of your list. You may be able to save tens of thousands of dollars each year, tax-free.  

But, getting started can be daunting. Different plan types have different rules. So, how do you find the best option? And who should you ask for help?

Recently, I went live on LinkedIn with Courtenay Shipley, President & Chief Planologist of Retirement Planology, to talk about what small business owners need to know about retirement plans. Check out our conversation in the video and interview highlights, below. 

The Jill James: What retirement plans should I be considering?

Courtenay Shipley: For small business owners, the most common options are a SEP, SIMPLE, or 401k – the links will open the IRS page for each. With or without a business, if you’re saving $6,000 or less, you can use a Traditional or Roth IRA. Retirement plans are federal, so it doesn’t matter where your business is located in the US. We all have the same options.

How much can I save? 

SIMPLE IRAs allow you to contribute up to $13,500 ($16,500 if you’re turning age 50 or older this year). 

In a SEP or 401k in 2020, it may be as much as $57,000 ($63,500 for age 50+). That’s a lot more than a traditional IRA or employee 401k! 

Your maximum contribution will depend on your plan type, company profit, and salary. Also check the IRS website for contribution limits, which change as often as annually, since they’re indexed to inflation.

What should I consider when choosing and designing a plan?

First, how profitable are you? How much do you want to save? 

If you want to save more than the lower SIMPLE threshold, your profitability and savings goals may help you decide whether a SEP or 401k is the right choice. Your SEP maximum is limited by your profits and wages, while a 401k is not.

Secondly, do you have employees, or intend to hire soon? What Safe Harbor and employer contribution requirements will you need to meet?

SEP and SIMPLE both have 100% immediate vesting on any amounts that you might give to employees. However, you can set a waiting period of up to three years for an employee to qualify. 

401ks can use a vesting schedule, where employees earn ownership of the employer contributions over a period of years of employment with you. You can also set up to a one year waiting period. 

Generally speaking, the more generous you can be with employees, the more generous the IRS lets you be with yourself in 401k contributions. 

While IRAs are not subject to non-discrimination testing, 401ks are. Safe Harbor testing means getting a pass for some people benefitting more than others. In general, owners/highly compensated employees can’t be benefiting from the plan substantially more than the rank and file or the IRS makes you jump through certain – sometimes expensive – hoops. But, if you can afford to give everyone a 3% contribution or a 4% match, you can forgo the testing.

Thirdly, what’s your appetite for fiduciary administration and overhead? What kind of investment options do you want within your plan?

In a 401k, you, as the plan sponsor, will have oversight on that investment menu piece and making sure the plan is run in alignment with the rules in its plan document. (Welcome to fiduciary responsibility, and welcome to a new overhead cost.) 

SEP and SIMPLE are both IRA plans, so employees are responsible for setting up their own accounts and selecting investments. 

When you run scenarios for the plan type, make sure to review it with your accountant to make sure you understand the costs as well as the tax savings! 

What deadlines do I need to meet?

If you don’t have an existing plan, you have two options for 2020: set up and fund either a SEP or a 401k in Q1. Note, with a 401k, you’ll be contributing employer profit sharing dollars only. Salary deferrals end on December 31.

You have until you file your 2020 taxes plus extensions, either March 15 or April 15, 2021, to get either plan open and funded. (This 401k deadline is new from 2020’s SECURE Act retirement plan reforms.) Check with your accountant for details. If you have an existing 401k, you will be able to make a profit sharing contribution through the time you file your taxes plus extensions. If you prefer to start a 401k in 2021, set that up as soon as possible so you can start making deferred salary contributions.

Other things to know about starting a plan?

In addition to the nice tax savings that you have, you may be able to claim a tax credit up to 50% of the costs for some of the ordinary and necessary costs of starting a SEP, SIMPLE IRA or 401k. Reminder: a tax credit reduces the amount of taxes you may owe on a dollar-for-dollar basis. Details here.

Who should I call to get one of these?

For yourself or just a few employees, your best options are a financial advisor, private wealth manager at your bank, or a brokerage specialist. 

If you have a larger number of employees – say, over 20 – and you’re starting to think not just in terms of your own tax and retirement savings but also company growth, retention, and recruiting, you’ll want to work with a retirement plan design specialist, like my team at Retirement Planology

Even with support, it’s a good idea to revisit your plan every couple of years to make sure it’s still living out it’s intended purpose. Start by answering this question: What’s this retirement plan supposed to do for me and my business?

More From Jill James

Blog Article

I blew all my money

Be a more strategic leader and more effective manager of your business finances by embracing the difference between investing and spending. I’ll show you how.

Read More »