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Saving Now May Save You Later: Retirement Planning for Small Business Owners

Retirement planning is probably the last thing a small business owner is thinking about. With the focus on creating relationships with new customers, developing a great product or service, and managing the day-to-day operations, there isn’t much time to think about retirement. However, there are a number of great benefits in considering developing a retirement planning vehicle for your small business. Retirement planning can be a great way to ensure that you don’t have to work as hard in the future, it can be a great recruiting mechanism as your company grows, and can significantly contribute to a reduced tax burden

There are a number of retirement planning tools available to small business owners and it is important to understand the value of each before deciding what may be best for your situation. Today I want to focus on three common plans available to small business owners. These three plans are the Simplified Employee Pension - Individual Retirement Account (“SEP-IRA”), Savings Incentive Match Plan for Employees - Individual Retirement Account (“SIMPLE - IRA”), and One Participant 401(k) (“Solo 401(k)”).

Simplified Employee Pension – Individual Retirement Account (“SEP – IRA”)

        I.            What Is a SEP – IRA?

A SEP – IRA is a tax-deferred retirement saving tool available to small business owners. A SEP – IRA is similar to a Traditional IRA but it allows a small business owner to make contributions to their own retirement and that of their employees.

     II.            How Do I Establish the Plan?

The IRS has a specific form, Form 5305-SEP, that can be used to establish a SEP - IRA. However, a small business owner can adopt a written plan including one provided by the financial institution if it meets all the requirements. Once the plan is establish be sure to provide information to your employees about the plan and how to sign up.

   III.            How Do My Employees and I Participate?

The IRS has created certain guidelines on who is eligible to participate in a SEP plan. A small business owner is required to include anyone who meets the following requirements: (1) Reached the age of 21, (2) Worked for business in three of the past five years, and (3) received compensation of at least $600. As the small business owner, you have the ability to create a less restrictive guideline for eligibility but cannot make the eligibility more restrictive.

   IV.            How Much Can Be Contributed to the Plan?

The employer is the only one that can contribute to a SEP - IRA plan. The employer can contribute up to the lesser of 25% of the compensation of the employee or $55,000 (2018). Compensation can include wages, tips, and other compensation. It can also include amounts under a deferred compensation plan but not deferred amounts under a Cafeteria plan. If the employer is contributing to their own plan, the contribution limits for compensation are calculated from net earnings and not from gross.

      V.            Bottomline

A SEP – IRA is a great retirement planning tool for larger small business owners. A SEP – IRA does not require a specified contribution amount by the employer and therefore can create flexibility in how much the business owner can afford to contribute to each employee’s plan.

Savings Incentive Match Plan for Employees – Individual Retirement Plan (“SIMPLE IRA”)

        I.            What Is a SIMPLE – IRA?

A SIMPLE – IRA is a retirement saving tool available to small business owners. It is a great way for the small business owner to start the retirement planning process for themselves and their employees.

     II.            How Do I Establish the Plan?

The IRS has a specific form, Form 5304 - SIMPLE or Form 5305 – SIMPLE. Form 5304 – SIMPLE allows the employee to choose their own financial institution, while Form 5305 – SIMPLE allows the employer to choose the financial institution. In addition, a small business owner can adopt a written plan including one provided by the financial institution if it meets all the requirements instead of using the forms provided by the IRS.

   III.            How Do My Employees and I Participate?

The IRS has created certain guidelines on who is eligible to participate in a SIMPLE plan. An owner is required to include anyone who meets the following requirements: (1) Employee earned at least $5,000 in any 2 years prior to current year and (2) Employee is expected to earn at least $5,000 in the current year. As the small business owner, you have the ability to create less restrictive guidelines for participation but cannot make participation more restrictive.

   IV.            How Much Can Be Contributed to the Plan?

An employer or an employee can contribute to the SIMPLE plan. An employer must either match up to 3% of employee’s compensation or contribute a non-elective non-matching contribution of 2%. For 2018, contributions are limited to $12,500 with an increased contribution limit of $15,500, if 50 years or older. Compensation can include wages, tips, and other compensation. It can also include amounts under a deferred compensation plan but not deferred amounts under a Cafeteria plan. If the employer is contributing to their own plan, the contribution limits for compensation are calculated from net earnings and not from gross.

      V.            Bottomline

A SIMPLE – IRA is great for small business owners who do not have a lot of employees, have a fairly small budget, but want to still contribute to their employee’s retirement. SIMPLE – IRAs can be fairly easy to maintain with a number of financial institutions offer services directed toward small business owners.

Self-Employed 401(K) – (“Solo 401(K)”)

        I.            What Is a Solo 401(K)?

A Solo 401(K) is retirement savings plan similar in structure to the more commonly known 401(K), that most employers offer their employees. The difference between the two plans is that a Solo 401(K) can only be used for the small business owner and his/her spouse. Employees cannot be covered under a Solo 401(K) plan.

     II.            How Do I Establish the Plan?

The IRS does not have a specific form that can be used to establish a Solo 401(K). In order to create a Solo 401(K), the small business owner must establish the plan on behalf of the business. The small business owner can adopt a written plan including one provided by the financial institution if it meets all the requirements. Once the assets in the plan exceed $250,000 the plan is required to file Form 5500-EZ with the IRS.

   III.            How Do My Employees and I Participate?

Under IRS provisions, participation in a Solo 401(k) is restricted to the small business owner and his/her spouse. Unlike some other plans, there are no restrictions on how much compensation must have been earned prior to the “employer” being required to contribute.

   IV.            How Much Can Be Contributed to the Plan?

An employee-owner can contribute up to $18,500 (2018) or if over 50 years old can contribute $24,500 (2018). An employer-owner can contribute up to 25% of compensation not to exceed $55,000. Compensation can include wages, tips, and other compensation. It can also include amounts under a deferred compensation plan but not deferred amounts under a Cafeteria plan. If the employer is contributing to their own plan, the contribution limits for compensation are calculated from net earnings and not from gross.

      V.            Bottomline

For a small business with only “mom & pop,” a Solo 401(K) is a great way to start the retirement saving process due to the simplicity and familiarity of a 401(K) style of plan. However, as the business grows a Solo 401(K) may not be the best option for providing retirement planning to your employees.  

Determining which plan is right for your situation can be a difficult decision to make. Things to consider are 1) initial cost to set up, 2) how many employees do I have or plan to have, and 3) which is going to provide me the best value for my situation. Robinson Legal can work with you and your financial advisor to create a plan that best fits your needs. Please feel free to set up an appointment to discuss how we can help you.