Small business and self-employed retirement plan options
If yours is one of the more than 33 million small businesses in the US, congratulations! You're making an essential contribution to the economy – and your hard work and accomplishments require you to make important decisions every day. One of the most significant decisions is choosing a retirement plan for yourself and any employees you may have. Fortunately, you have a number of options available to you. This article will look at the following business scenarios to help you understand your choices:
Starting a new business, owner only - Traditional or Roth IRA
Solo owner, no employees (other than a spouse or business partner) - Solo 401(k)
Business owner with no or few employees - SEP IRA
Business owner with up to 100 employees – SIMPLE IRA
Think about how much you want to contribute – and where you want your business to go
As you’re looking to make the right retirement plan choice it will help to start by having an idea of how much money you’ll likely want to contribute (Guardian’s retirement calculator can help). The type of business you want to build will also impact your decision because the number of employees you plan to have will impact your choice of plans.
With a basic understanding of the different types of small business retirement plans and how they work for different types of small businesses, you'll realize the dollars you and your employees contribute can go just as far as they would in a 401(k) plan from an established employer. And if you're just starting out, you'll find that many of these options also apply if you are self-employed and don’t have any employees just yet.
1. Starting a new business, owner only (Traditional or Roth IRA)
What is a traditional IRA? What is a Roth IRA?
An IRA, or Individual Retirement Account, is a tax-advantaged savings plan you can open for yourself. There are two basic kinds: The first, a traditional IRA, lets you make tax-deductible contributions to an account (which lowers your taxable income for the year), and funds in the account are invested and grow tax-deferred until they are withdrawn in retirement. The second type, a Roth IRA, has a different set of advantages: funds that go into the account are “post-tax dollars” taxed as ordinary income (so there’s no tax benefit as you contribute), but funds in the Roth account grow without being taxed, and when you make “qualified” withdrawals in retirement the entire amount is income tax-free.
IRA tax considerations
Traditional: Contributions aren’t taxed in the current year, and funds grow without being taxed until they are withdrawn in retirement (after age 59½); after that, money taken out of the account is treated as ordinary income.
Roth: Contributions to your account are taxed as ordinary income; funds in the account grow without being taxed, and withdrawals in retirement are tax-free.
IRA contribution limits
For 2024, the contribution maximum for an IRA is $7,000. If you are age 50 or older, the catch-up contribution is $1,000, for a total of $8,000 come limits for Roth IRA contributions based on your MAGI (modified adjusted gross income) and filing status (i.e., single, married filing jointly, or married filing separately).1 If you are considered an active participant in a retirement plan at work during any part of the year, the deductibility of your Traditional IRA contributions is determined by your MAGI and your tax filing status.1 If you are considered an active participant in a retirement plan at work during any part of the year, the deductibility of your Traditional IRA contributions is determined by your MAGI and your tax filing status.2
The decision comes down to…
IRAs have relatively low contribution limits compared to other kinds of plans, so you have to decide whether $7,000 (or $8,000 if you’re over 50) is enough to set aside for retirement. But if you choose to open this type of retirement account, you still have to decide between a traditional or Roth IRA or a combination of the two.
Do you think you will be in a higher tax bracket now or when you choose to retire? People typically assume that their income – and tax bracket – will be reduced in retirement, and if you think that will be true for you, a traditional IRA tends to make more sense. However, if your new business is very successful, you may have more income in retirement than you do now. In this situation, you might be better off with a Roth IRA that offers tax-free withdrawals.
2. Solo owner, no employees (other than a spouse or business partner) - Solo 401(k)
What is a solo 401(k)?
A 401(k) is a company-sponsored account that enables employees to contribute pre-tax income through their paychecks. Some plans also allow for Roth 401(k) so employees can contribute on an after-tax basis, similar to the Roth IRA. Employers frequently make matching contributions to these contributions, which are invested and grow tax-deferred until they are withdrawn in retirement. Solo 401(k)s are similar to employer-sponsored 401(k)s because of this tax-deferred feature, but you open, fund, and manage the plan on your own. Think of it as a 401(k) plan with one participant, you. If your spouse should happen to work for you, if you have a business partner, or if your children are employed, they are also eligible for participation.
Solo 401(k) tax considerations
The contributions you make are pre-tax, or maybe after-tax, and grow tax-deferred – you don't pay income taxes on that money – and funds in the account grow tax-free. You are eligible to take distributions from the plan, usually starting at age 59½, and those distributions are taxed as ordinary income unless you also contributed to the Roth feature. The plan may allow for loans to provide access to your funds, and unlike an IRA, should you separate from service at age 55, there is no 10% penalty (in an IRA, there is a penalty to distribute funds prior to age 59 ½ with limited exceptions).
Solo 401(k) contribution limits
A 401(k) is a feature of a Profit-Sharing Plan. For 2024, the annual contribution maximum is $69,000, with an over-50 catch-up of $7,500 for a total of $76,500.3 It is important to note that these figures include a deferral of your own salary, a Roth feature, or a combination of both, up to $23,000 in 2024, along with an employer contribution (known as profit sharing) of $46,000 in 2024. These amounts may be indexed each year.
The decision comes down to…
If you want to put aside more than $7,000 or $8,000 for retirement – and lower your present year taxable income more significantly, then this type of plan may be a better choice than an IRA. Another consideration is the investments and adding an insured survivor benefit through life insurance, which is not allowed in IRAs. But there's another important consideration: Do you think you will have many employees working for your business besides a spouse or business partner? If so, you might want to consider other types of savings plans.
3. Business owner with no or few employees - SEP IRA
What is a SEP IRA?
SEP stands for Simplified Employee Pension and is similar to a Profit-Sharing Plan. Like a Profit-Sharing Plan contributions are made with tax-deductible (which reduces taxable income), funds in the account grow tax-deferred, and income is taxed when you withdraw funds in retirement. Under the SECURE Act, the SEP contributions may be treated as Roth, with no tax deduction but the potential for tax free income in retirement. However, a SEP IRA, based on your compensation, offers the potential for significantly higher contributions than a traditional IRA. SEP IRA contributions are made by you, which lowers your taxable income if you are self-employed, or not if you decide to have contributions treated as Roth. If you own a small business, this also lets you contribute to your employees’ retirement – your employees make investment decisions and manage their own accounts. However, these plans typically aren’t adopted by larger businesses because they have a number of restrictions; for example, they don’t allow for employee contributions, participant loans, vesting, or insured death benefits.
SEP IRA tax considerations
Like a traditional IRA plan, your SEP IRA contributions reduce current-year taxes and benefit from tax-deferred growth until retirement. Or, you may decide the Roth option is for you. And, when you take distributions in retirement, your distributions are taxed as ordinary income, or if you chose the Roth option, possible tax-free income. These plans are also subject to many of the same types of limitations; for example, if you withdraw the funds prior to age 59½, you will typically be subject to income taxes and a 10% penalty.
For employers, contributions are tax deductible in the current year. For employees, contributions and earnings are not taxed until withdrawn in retirement.
SEP IRA contribution limits
Contributions are generally limited to 25% of your net earnings from self-employment – or 25% of an employee’s compensation– up to $69,000 in 2024. Some restrictions and limitations apply, but on the positive side, you can typically contribute to your SEP IRA and still contribute to a traditional or Roth IRA, but on the positive side, you can typically contribute to your SEP IRA and still contribute to a traditional or Roth IRA.
The decision comes down to…
Are you looking for a way to make higher contributions to your retirement plan? If you have employees, are you willing to contribute at the same rate for each employee? Or if you are earning more than your employees and willing to hire an administrator, your SEP may be integrated with your contributions to Social Security to provide you with greater contributions and offset your Social Security retirement contributions towards your employees. And will they be satisfied with a plan that only allows for employer contributions? If the answer to each question is yes, a SEP IRA is easy to set up and lets you make higher contributions than other vehicles like an IRA). Also, you can skip contributions in years when profits are low for your business.
4. Business owner with up to 100 employees – SIMPLE IRA
What is a SIMPLE IRA?
A SIMPLE IRA stands for Savings Incentive Match Plan for Employees. These plans are intended for businesses with 100 or fewer employees (including sole proprietors), and contributions are made in one of two forms:
You, as the employer, can withhold 2% of an employee's salary as a “non-elective” plan contribution, or
As the employer, you can incentivize workers to contribute with a dollar-for-dollar match of their contributions to the plan, up to 3% of their salary.
SIMPLE IRA tax considerations
Contributions made by you (the employer) to a SIMPLE IRA are tax-deductible for the company. Individual contributions are pre-tax or may be made as Roth for employees, reducing their taxable income or not. Like a traditional IRA, investments grow tax-deferred, and as distributions are made in retirement, they are considered ordinary taxable income unless they decide to contribute as Roth or a combination of them. Also, early withdrawals before the age of 59½ are typically subject to a 10% penalty in addition to regular income tax.
SIMPLE IRA contribution limits
For 2024, the contribution limit for employees is $16,000, with a catch-up contribution for those 50 or older of $3,500 to total $19,500.5 Considered an employer-sponsored retirement plan, employer contributions are mandatory.
Employer contributions can be made by providing matching contributions up to 3% of the employee’s pay, with no annual compensation limits but a maximum employer contribution per employee of $16,000. Employers may also choose to make non-elective contributions equal to 2% of the employee’s compensation based on a maximum salary of $345,000 in 2024.6 Starting in 2024, employers can also make additional contributions to each employee, providing the contribution does not exceed the lesser of up to 10% of compensation or $5,000.
The decision comes down to…
Are you looking for the highest contribution limits available for a retirement savings vehicle? If so, you could find other plans, like a SEP IRA or Solo 401(k), with higher contribution levels. Also, if you are not interested in making employer contributions, this might not be the best plan choice for your business.
Guardian can help
Choosing the right retirement savings plan for a small business is a multi-layered decision. These guidelines are meant to help you narrow down your options based on the size of your business and whether you have or plan to hire employees. In any case, it’s a good idea to consult with a financial professional to help make sure you’re taking the right action. If you don’t know such a person, we can help. A Guardian financial professional will listen to your needs, help define your goals, discuss options for providing executive team benefits, and work with you to better understand the retirement planning process and make the right decisions. Here’s how to find someone near you:
Frequently asked questions about small business retirement plans
The best retirement plan for a business owner depends on several factors: how new your business is, how close you are to retirement, how much money you're trying to save (vs. put into your business), as well as how many employees you have or expect to have. The good news is that there are many options available to help you save, such as a Traditional or Roth IRA, SEP IRA, SIMPLE IRA, or Solo 401(k).
If you own a business or are self-employed, you can set up a savings plan that will help you accumulate funds for retirement in much the same way as if you worked for someone else and contributed to the company's retirement plan. The difference is that as the decision maker, you have various plan options available to you – such as Traditional and Roth IRAs, SEP (Self Employed Retirement Plans), SIMPLE IRA, or a Solo 401(k). However, each option has somewhat different features and tax benefits and requires varying amounts of administrative attention. For example, some let you set up or contribute to employee retirement accounts, and others don't, so it helps to work with a financial professional who can help you choose and manage the right small business retirement plan for your needs.
More commonly known as a pension plan, investments in a defined benefit plan are managed by you (the employer). These plans provide a guaranteed fixed benefit to employees once they retire based on factors like salary and length of service. Most defined benefit plans fell out of favor with employers with the advent of 401(k) plans in the 1980s, which shifted the payment burden from employers to employees.
While these plans have very high contribution limits, consideration about profitability and cash flow may be a concern, as contributions must be made each year, with limited exceptions.
A 401(k) could be an excellent choice for a small business owner and their employees to attract and retain quality employees and help save for retirement. If you are a business owner with no employees (or self-employed individuals), you may consider a Solo 401(k), which allows some of the highest contributions of any retirement plan and is relatively easy to administer and manage. Other plans are also available, such as a SIMPLE IRA, to help your employees get on the right track for retirement.
It boils down to how much you want to contribute, how much tax savings you are looking for, and how much retirement income you are going to need.