As a small-business owner, your retirement plan decisions can affect your near-term tax liability and your flexibility to grow your assets, along with your company over time.
Basically there are two types of retirement plans. Qualified plans, such as, 401(k)s, pension plans or profit sharing plans, are subject to strict Internal Revenue Code and ERISA (Employee Retirement Income Security Act) guidelines in exchange for pre-tax contributions and tax-deferred growth. Non-qualified plans are not subject to ERISA guidelines, and as a result, can be less expensive to administer.
As a new business owner, there are several factors that can influence your choice of retirement plans, including how many employees you have, how much extra cash flow you have to devote to retirement savings and your short-term and long-term tax benefits. Typically, a new business owner has more startup costs in the first years. Because many of the startup costs can offset income, the immediate tax benefits of establishing a retirement plan may not be as important. Since income is generally lower in the first few years, you may consider a traditional or Roth IRA. The contribution limit for 2015 is $5,500 for those under age 50. In your first year of business, if you cannot contribute more than that, it may be easiest to opt for a traditional or Roth IRA.
If you are able to defer more than $5,500, two popular plans to consider are a SEP (Simplified Employee Pension) IRA and a Solo 401(k), as both offer generous limits for self-employed individuals. A SEP IRA is basically a “souped- up” IRA that allows tax-deductible employer contributions. In 2015, you can defer up to 25% of your net earnings from self-employment, provided the amount does not exceed $53,000. Contributions are made on a discretionary basis, so the employer decides each year whether to make contributions. However, if you have employees, you must contribute the same salary percentage on each employee’s behalf, which can get expensive for the business as you hire more employees, especially if they are paid similar to you.
Solo 401(k)s are designed for a business owner with no employees other than his or her spouse. With a Solo 401(k) you can defer 100% of compensation up to $18,000 while the employer may contribute up to 25% of compensation as long as the total contributions do not exceed $53,000, or 100% of compensation in 2015. While a Solo 401(k) requires more administrative attention, you may be able to borrow money from the plan during down years.
You can establish and fund a SEP-IRA up to your tax filing deadline. With a Solo 401(k), you must establish and fund employee deferrals to the plan by year-end, but have until the tax filing deadline to fund employer contributions. However, with either plan, it may be best to make contributions at regular intervals, such as monthly or quarterly, to take advantage of multiple entry points into the market.
Once you establish a retirement plan for your business, you are not locked into it for life. As the business grows, you may consider changing your retirement plan to take advantage of the tax deductions for the business or to enhance your benefits package to attract talented employees.
If you have questions regarding which retirement plan you should establish as a self-employed individual, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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