Retirement Plans For Small Business Owners – An important aspect of effectively managing a small business is establishing a retirement plan that is appropriate for your organization. Figuring out the right retirement plan is an area in which we often advise our small business owner clients. As many of our clients grow their businesses, we’ve helped them replace their existing company retirement plans with 401(k) plans. In general, 401(k) plans can provide more options and flexibility than other types of retirement plans. Here, we’ll explore some of the key features of 401(k) plans and the potential benefits they can provide on a personal level and in various aspects of running your business.
Business owners can often face challenges in attracting and hiring top talent. Of course, they want to staff their organizations with the most qualified candidates, but highly experienced or specialized professionals are more likely to accept positions in larger organizations with more generous benefits packages. A 401(k) plan can provide an advantage in employment because many job seekers consider 401(k)s more robust than other types of retirement plans and, frankly, 401(k)s are more well-known and recognized. done Additionally, 401(k)s can help you retain key talent through certain plan features, such as phasing out company contributions.
Retirement Plans For Small Business Owners
Another benefit of 401(k) plans is that they can provide a great opportunity to save for your own retirement as a business owner—sometimes more than other types of retirement plans like SEPs or SIMPLE IRAs. Significantly more. It is important to note that a 401(k) is a type of defined contribution plan. In 2022, the IRS set the maximum contribution for defined contribution plans at $61,000 and $67,500 for individuals age 50 and older. In order to maximize contributions up to the annual defined contribution limit, it is generally important for a 401(k) plan to include a profit-sharing component. As a business owner, you contribute to your 401(k) account as an employee and as an employer through a combination of 401(k) salary deferrals, company contributions, and company profit sharing contributions. will, as described below:
Retirement Plans For Small Business Owners
401(k) salary deferral (employee contribution) – up to $20,500 in 2022 ($6,500 additional contribution for $27,000 in 2022 for participants 50 and older)
401(k) Matching Contributions (Employer Contributions) – Company matching contributions can be based on a fixed dollar amount or a specific matching formula, but the most common type of company contribution is a safe harbor contribution. Generally, the safe harbor contribution can match up to 4% of each employee’s salary on a deferred basis or a non-elective portion of 3% of the employee’s salary regardless of whether the employee is in the plan. Under the safe harbor rules, the company’s share is immediately 100% protected.
Profit Sharing Contribution (Employer Contribution) – This refers to a company contribution based on an additional formula that allows employees to share in company profits. Profit sharing contributions can be discretionary, meaning that the company can choose whether to contribute from year to year. However, certain criteria must be met so that profit sharing does not discriminate in favor of highly paid employees in order to comply with ERISA regulations. Profit sharing contributions may be subject to a vesting schedule to encourage employee retention.
Janet, a business owner, established a Safe Harbor 401(k)/profit sharing plan as her company’s retirement plan for herself and her employees. Janet is 55 years old and receives $175,000 in annual W-2 income from her company. The maximum employee deferral is $20,500 and she is eligible for a maximum contribution of $6,500 because she is over 50, making her total contribution $27,000. When Janet set up her company’s 401(k) plan, she chose to include safe harbor matching contributions using a basic matching formula of up to 4% of salary. Thus, Janet can make a $7,000 matching contribution from her company’s assets (4% of $175,000). Finally, Janet completes the company’s profit-sharing contributions of $33,500 to her account while minimizing the company’s profit-sharing contribution to her employees and still deducting the 401(k) plan. Thus, Janet can increase her 2022 401(k)/profit sharing plan contributions up to the IRS limit of $67,500, under the discretionary approach. $27,000 + $7,000 + $33,500 = $67,500.
Owners’ Fringe Benefits, Retirement, And Tax Deferment
In addition to serving as a tool to promote the acquisition and retention of key talent and an excellent retirement savings vehicle, 401(k) plans also provide business owners with numerous tax benefits.
If a business owner ends up deferring wages on a pre-tax basis, they can reduce their taxable income by up to $27,000 in 2022 if they’re over age 50. The account is also tax-deductible for the employer, subject to certain limitations.
There are also several 401(k) tax credits available to small business owners. Small businesses, with 100 or fewer employees, can qualify for a tax credit for each of the first 3 years when they first start a new 401(k) plan. Another tax credit exists for plans that provide for automatic enrollment of new employees, encouraging small business owners to add automatic enrollment as a feature of their plan. Finally, plan administration costs/administrative costs paid by the business can be deducted as business expenses. Note that you cannot deduct initial expenses and claim the aforementioned credit on the same expenses.
As always, Modera is here to help you evaluate your specific needs and potential options as you choose the right retirement plan for your business. Please contact your wealth manager if you have any questions.
Retirement Plans For The Small Business Owner
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Investing in the markets has its advantages and disadvantages and may not be suitable for all investors. The information contained herein is subject to change without notice and should not be considered a solicitation to buy or sell any security or to engage in any particular investment or financial planning strategy. An individual client’s asset allocation and investment strategy will vary depending on varying degrees of diversification and other factors. Diversification does not guarantee profit nor does it guarantee loss. Imagine no longer waking up in the middle of the night worrying about how (or if) retirement will ever become a reality. Imagine skilled workers joining your small business — and staying. It all starts with a smart retirement plan for small business owners. Bakery owners up to their elbows in cookie dough probably don’t have much time for small business retirement. And freelancers can place a high priority on cash flow while living in the present at the expense of a secure future by co-writing contracts.
These are just examples. More broadly, the business entities of companies with one to 100 employees are so intent on keeping the lights on or raising extra money to grow their business that creating a retirement plan for their small business piles on the responsibility. In fact, a TDAmeritrade Holding Corporation survey found that 55 percent of self-employed small business owners say they are behind on their retirement savings.
Retirement Planning For A Small Business Owner In Canada
Figure 1: Income volatility is the primary reason why small business owners and the self-employed stop saving for retirement. Other requests are always there. Source: TDAmeritrade Holding Corporation Self-Employment and Retirement Research by Head Research (a separate and unrelated firm).
Living longer is usually a good thing. However, there are many modern complications in retirement planning, including vulnerable Social Security programs, volatile financial markets, and the real risk that tuition and help for elderly parents may be needed.
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