Entrepreneurs and small-business owners have several options for tax-advantaged retirement savings.
You can use a small-business retirement account in addition to a traditional or Roth IRA to maximize savings.
When you own a small business, you may find that retirement planning is last on your to-do list. But getting started isn’t as hard it seems. Here, we outline the most common self-employment retirement options, who should use them, what you can contribute, and how to set them up.
One-Participant 401(k) Plan
This plan, typically called a Solo 401(k), is similar to a regular 401(k). However, with the Solo 401(k), the participant is both employer and employee, and he or she can contribute up to the regular employee contribution limit plus 25% of the business’s net earnings. You can also set it up as a Roth 401(k) and make non-deductible contributions now and take tax-free withdrawals after retirement. (See the IRS guidelines.)
Who: Self-employed people who have no employees (or only employ their spouse)
Setup: Setup requires completing paperwork with investment companies that offer Solo 401(k)s. Be sure to research plan and investment fees.
Contribution Limits: In 2015, you can contribute up to $18,000 as an employee plus up to 25% of compensation as an employer, as long as your total contribution does not top $53,000. If you are 50 or older, you can ‘catch up’ with an additional $6,000 ($59,000 total). Note that if you are also participating in another employer’s 401(k), these limits apply per person, not per plan. (See IRS guidelines.)
Dates to Know: You must set up the account by by Dec. 31, but you can contribute until April 15 of the following year.
SEP (Simplified Employee Pension) IRA
The SEP IRA is another excellent option. With a SEP, the business sets up an IRA for each employee. Only the employer can contribute, and the contribution rate must be the same for each qualifying employee.
Who: Self-employed or small-business owners who do not qualify for a Solo 401(k), or who have employees and are looking for a low-cost retirement plan for their company.
Setup: Simply file a form with the IRS (Form 5305-SEP) and open a SEP IRA at a bank or financial institution.
Contribution Limits: For 2015, up to 25% of employee compensation (or net earnings from self-employment) or up to $53,000, whichever is less. There is no ‘catch-up’ amount. The limit was $52,000 for 2014. (See IRS guidelines.)
Dates to Know: Set up by April 15, 2015, and you can contribute for 2014 until your taxes are filed.
SIMPLE (Savings Incentive Match Plan for Employees) IRA
This plan is ideal for small-business owners who have 100 employees or less. Both employer and employee can contribute.
Who: Ideal for small-business owners with employees.
Contribution Limits: For qualifying employees (earning more than $5,000), the 2015 maximum is $12,500. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. ‘Catch up’ with $2,500 extra per year if you’re 50 or older. (See IRS guidelines.)
Dates to Know: Must open by Oct. 1 of the year you want to contribute.
Traditional or Roth IRA
In addition to one of these business-sponsored accounts, you can also fund a traditional or Roth IRA.
If you’re looking to use a traditional IRA and get an income tax deduction, you may be limited in that deduction by your contributions to other retirement accounts and by your level of earned income (you will need to review the IRS guidelines).
Note: If you’re a new business owner or entrepreneur just starting out, you may find yourself in a lower tax bracket, which may mean it’s a good time to convert an old 401(k) or traditional IRA into a Roth. That means you can capture lower taxes today and withdraw that money from your Roth tax-free when you’re in retirement. Learn more about a Roth conversion. You can also roll over your old 401(k) into an IRA.
Who: Anyone with earned income can contribute to an IRA.
Setup: Open a Roth or traditional IRA with a low-cost provider (bank or financial institution).
Contribution Limits: Maximum of $5,500 per year to a traditional or Roth IRA, or $6,500 if you’re age 50 or older; Roth contributions may be limited by income.
Dates to Know: You have up until April 15 to contribute to an IRA for the preceding year. You can open these at any time.
How to Choose
Which tax-advantaged account should you use? That depends on the nature and size of your small business (with or without employees) and your own age and plans.
Here’s the scenario for an entrepreneur (age 30) with no other employees and who is classified as a single owner corporation. The business nets $100,000 in 2015.
|Type of Plan||Maximum Contribution (2015)|
|Solo 401(k) plan||$43,000|
Based on this chart, you might be wondering why anyone would do anything but the Solo 401(k).
Here is why: First, setting up an individual 401(k) typically requires more advance planning and paperwork than opening a SEP or SIMPLE IRA (either can usually be done online in just a few minutes). In addition, individual 401(k) plans require you to file Form 5500-EZ with the IRS every year once the plan reaches $250,000 in assets. And of course, with the solo 401(k) you have to be your own company with no employees.
And remember, if your circumstances change, you may be able to roll over your Solo 401(k) plan or consolidate your IRAs into a more appropriate retirement savings account.
Betterment is not a tax advisor, and this post is not tax advice. Please seek out qualified professionals that provide advice on these issues for your specific circumstances.
When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. The information on this page is being provided for general informational purposes and is not intended to be an individualized recommendation that you take any particular action.
Factors that you should consider in evaluating a potential rollover include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account and consult tax and other advisors with any questions about your personal situation.
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