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GENERAL BUSINESS

How to Save for Retirement as a Small Business Owner or When Self-Employed

7-minute read

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Emily Thompson

Emily Thompson

23 November 2022

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When you think about your retirement, what does it look like? Have you taken time to think about it? For many small business owners, the answer is no. After all, it can be a lot just to get through each week, month, quarter, or year.

But if you keep pushing off retirement planning, you might never achieve your goals. According to one report, one in four Americans aren’t saving for retirement at all. Of the Americans who do save, most of them aren’t putting away enough cash to live comfortably later on.

If you don’t save for retirement, you may have to continue working, even if you have health issues or feel tired. You might not get to enjoy your “golden years” by traveling, spending time with family, or pursuing hobbies. And worst-case scenario, you might have to scale back on your lifestyle, including living in a smaller home, budgeting more, and buying less.

Why a Retirement Plan is Important

Setting up a retirement plan and saving enough money is incredibly important for your well-being. It allows you to enjoy your aging years and can help prevent financial stress.

Here are a few other reasons why you should consider getting a retirement plan:

  • Social Security benefits usually aren’t enough to live on comfortably. The average check is just $1,542.22 a month in Social Security benefits. For many people, it’s even less. Just imagine living off that amount. Could you pay for your housing, food, and other costs? Would you have anything left over for your enjoyment or hobbies?
  • Your loved ones might not be able to take care of you. Most parents don’t want to be a burden to their adult children or other loved ones. After all, your adult children have their own financial goals and families to provide for. Retirement savings allow you to stay independent and provide for yourself in your later years.
  • A retirement plan is financially wise. Investing in your retirement can increase your wealth. Many retirement accounts accrue interest over time or rely on the stock market to grow savings. It can be a good idea to set up a retirement account as early as possible in your career. This way, your money is working hard (just like you). By the time you’re ready to retire, your wealth will likely have increased over time, allowing you to live more comfortably.

Small Business Retirement Plan Options: Types of Retirement Plans for Small Business Owners & Self-Employed Workers

If you’re ready to begin choosing a retirement plan for your small business, we applaud you. As a small business owner, it can be difficult to save extra cash in an account. But if it’s possible to adjust your budget and start saving for the years ahead, you have a few different options. Here are some popular retirement plans to consider.

Retirement Plan Type: Traditional or Roth IRA

If you’re just starting out as a small business owner, a traditional or Roth IRA may be your best bet. If you’ve had a regular, full-time job with a company, you may be familiar with this type of account.

IRAs typically offer several benefits. They’re easy to open and contribute to, and they offer several tax benefits. If you open a traditional IRA, you may be eligible to receive a deduction on the money you contribute each year. This can help lower the amount of taxes you will pay at tax time—typically, April 15.

On the other hand, if you contribute to a Roth IRA, you usually won’t receive an immediate tax benefit. Instead, when it’s time to withdraw your money, it’s usually tax-free.

How do I open a traditional IRA: It’s also easy to open a traditional or Roth IRA. All you have to do is contact a reputable bank or brokerage. You may even be able to open an account online and set up automatic deductions. A set-it-and-forget-it approach can help you keep saving and getting closer to your goals.

In 2022, the IRA contribution limit is $6,000 ($7,000 if you’re 50 or older), and in 2023, the contribution limit is $6,500 ($7,500 if you’re 50 or older). Plus, you get a tax deduction on the money you contribute to a traditional IRA.

Retirement Plan Type: Solo 401k

If you’re self-employed with no other employees, except perhaps a spouse who works with you, a Solo 401(k) might be right for you.

When you contribute to a Solo 401(k), you can add funds as an employee and as an employer. This greatly increases the amount you can contribute on a yearly basis.

For example, in 2022, you can contribute a maximum of $61,000, plus a $6,500 catch-up contribution or 100% of earned income. In 2023, you can contribute even more: $66,000, plus a $6,500 catch-up contribution or 100% of earned income.

How to calculate solo 401k contribution: As an employee, you can set aside $20,500 (in 2022) or $22,500 (in 2023), plus the $6,500 catch-up contribution (in 2022) or $7,500 (in 2023). And as an employer, you can contribute an additional 25% of your compensation. Remember, the big benefit is that your income is tax-deferred. Because you’re putting it away for later, you don’t have to pay taxes on it now. Nice!

How to open a Solo 401(k) plan: To open a Solo 401(k), find a reputable broker. Many of them offer a simple, online process for setting up your account and having automatic deductions.

Retirement Plan Type: SEP IRA

A SEP IRA is another type of retirement plan designed for self-employed people and small business owners with just a few employees. So how is it different from a Solo 401(k)? We’re glad you asked.

Here’s the key difference: If you have plans to hire an employee in the future, you should look at getting a SEP IRA. A Solo 401(k) is essentially only for a self-employed individual, and possibly, their spouse.

Meanwhile, a SEP IRA allows you to add employees to the plan. We encourage you to think about your hiring plans now, because it can be difficult to switch from a Solo 401(k) to a SEP IRA at a later date.

In addition, you can’t contribute as much money to a SEP IRA, and you can contribute only as the employer. Your employees do not contribute. In 2022, the contribution limit is $61,000 ($66,000 in 2023) or 25% of your net self-employment earnings or compensation—whichever is the lesser of the two. There is also a $305,000 limit on compensation that you can use to determine the contribution. In 2023, the limit is $330,000.

Like a traditional IRA, a SEP IRA offers tax advantages. For example, you can deduct the lesser of your contributions, or 25% of your net self-employment earnings or compensation.

However, a SEP IRA works like a traditional IRA, so anything you take out at retirement is taxed as income. A SEP IRA doesn’t offer a Roth version that allows you to contribute after-tax money. You will likely have to pay income taxes on withdrawals after age 59½.

The bottom line: A Solo 401(k) can offer better tax benefits than a SEP IRA depending on your needs because the contribution limits are much higher. If you’re truly self-employed with no plans to hire an employee, consider the Solo 401(k) over the SEP IRA.

But if you’d like to hire even one employee in the future, you can opt for a SEP IRA. Another difference—you may have an easier time maintaining a SEP IRA. There’s usually less paperwork and reporting to the IRS. Plus, a SEP IRA is fairly flexible; you generally don’t have to contribute to it every year.

How do I open a SEP IRA: It’s simple and takes only a few minutes. You can open a SEP IRA at most online brokerages. You’ll just need to complete a few online forms first.

Retirement Plan Type: SIMPLE IRA

If you’re researching retirement plans, you may have heard of a SIMPLE IRA. This is just another option to consider, but it’s often best for larger businesses with up to 100 employees. In contrast to a SEP IRA, you and your employees contribute to this type of plan.

With a SIMPLE IRA, you can contribute up to $14,000 ($15,500 in 2023), as well as a catch-up contribution of $3,000 if you’re age 50+ (it’s $3,500 in 2023). The maximum amount you can contribute to this plan in 2022 is $20,500 (the max is $22,500 in 2023).

You can generally deduct all of your contributions to a SIMPLE IRA, which is a clear tax benefit. You can also make a business expense deduction on your employee contributions to retirement accounts. But keep in mind that when it’s time to withdraw funds, you’ll pay taxes on your distributions.

How to open a SIMPLE IRA: Just like a SEP IRA, you can open a SIMPLE IRA on an online brokerage. Expect to have to complete more paperwork than with a traditional IRA.

Retirement Plan Type: Defined benefit plan

Think you can’t have a pension as a self-employed person? Think again. A defined benefit plan is one way to secure a pension. A defined benefit plan will give you a steady income stream once you retire—and it could last a while. This type of plan is best for self-employed business owners without employees who earn a high income and want to save a lot of money quickly for retirement.

Contributions to a defined benefit plan are tax-deductible, and the amount you distribute upon retirement is taxed as income. In general, defined benefit plans offer tremendous financial safety when you retire, but they’re expensive to set up and maintain.

They also carry some administrative burden, and you’re required to contribute to the plan every year, even if you have a bad business year.

That said, if you think you can save quite a bit of money every year (for instance, $50K to $80K), you may want to open a defined benefit plan and reap the rewards when you retire. It’s nice to have a pension-like fund in your later years.

How to open a defined benefit plan: To open a defined benefit plan, you should reach out to a broker and possibly an accountant. You’ll likely need to open it by your personal tax filing deadline. Usually this is April 15 or October 15, if you filed for an extension.

The Importance of Making Business Insurance Part of Your Retirement Plan

When you begin funding your retirement plan—no matter which one you choose—it’s critical to get business insurance along the way. Business insurance, including general liability and professional liability insurance, can help protect your finances, including your retirement plan (up to your policy limits).

Just think, without business insurance, if something catastrophic and costly were to happen to your business, you might have to dip into your retirement account. This could drastically diminish your funds upon retirement and even prevent retirement altogether.

If you’re interested in learning about the types of policies you need, check out our business insurance page and get an online quote today. Getting a quote takes just minutes and is incredibly easy. Trust us, getting insured should be at the top of your to-do list when you open your retirement account.

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Remember, the Earlier You Begin Saving, the Better

In general, retirement accounts can grow over time—even through volatile markets. The earlier you start saving for your retirement, the more likely you are to achieve your financial goals. And who knows, maybe you can even retire early.

Take a moment today to think about the bigger picture and where you see yourself in the years ahead. Then pick a retirement planning strategy and start saving for your future. You won’t regret it.

Emily Thompson

Written by

Emily Thompson

I earned a B.A. in Journalism from the University of Wisconsin at Madison (go Bucky). After realizing my first job might involve carrying a police scanner at 2 am in pursuit of “newsworthy” crimes, I decided I was better suited for freelance blogging and marketing writing. Since 2010, I’ve owned my freelance writing business, EST Creative. When I’m not penning, doodling ideas, or chatting with clients, you’ll find me hiking with my husband, baby boy, and 2 mischievous mutts.

This content is for general, informational purposes only and is not intended to provide legal, tax, accounting, or financial advice. Please obtain expert advice from industry specific professionals who may better understand your business’s needs. Read our full disclaimer

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