Small business owners often spend years reinvesting profits into their companies while putting their own retirement savings on the back burner.
Choosing the right retirement plans for small business owners can help entrepreneurs build retirement savings without losing sight of current business needs.
Retirement planning deserves separate attention when the owner also runs the company.
Business Value Is Not the Same as Retirement Savings
A profitable company can still leave an owner financially exposed if most wealth remains tied to the business.
Retirement Planning Should Start Before an Exit
Plan years ahead rather than waiting until the owner is ready to sell, transfer, or close the company.
Retirement Benefits Can Also Help With Employee Retention
The Department of Labor notes that retirement plans can help small businesses attract and retain employees while providing potential tax advantages.
Retirement Plan Options for Small Business Owners
The different plans involve different levels of employer contributions, administration, employee participation, and fiduciary responsibilities. The Department of Labor specifically identifies 401(k)s, profit-sharing plans, SIMPLE IRAs, SEP plans, and payroll-deduction IRAs among the options available to small businesses.
SEP IRA
It is designed for employer contributions. Businesses of any size, including self-employed individuals, can establish one. It is a relatively straightforward structure. Contributions are made to SEP-IRAs established for employees. Potentially useful when the owner wants a relatively simple arrangement.
The IRS says SEP plans do not have the start-up and operating costs of a conventional retirement plan and allow employer contributions subject to applicable limits.
SIMPLE IRA
It is designed specifically for smaller employers. Employees can contribute to it. Employers generally have contribution obligations. Can provide a straightforward way to offer retirement benefits.
Small Business 401(k)
It involves:
- Employee salary deferrals.
- Potential employer contributions.
- Greater flexibility than some simpler retirement arrangements.
- Investment options for participants.
- Additional administration and compliance considerations.
The Department of Labor notes that 401(k) plans can benefit both employees and employers and can offer tax advantages.
Profit-Sharing Plans
Employer contributions can be linked to company profitability or made on a discretionary basis.
The DOL describes profit-sharing plans as an option where the employer makes a discretionary contribution based on company earnings.
Benefits and Other Pension Plans
Traditional pension plans for small business owners who may have different retirement-income objectives.
These arrangements can involve more complex actuarial and administrative requirements, making professional guidance particularly important.
Small Business Owner Retirement Strategies
Separate Business Wealth From Retirement Wealth
Owners should not assume the future sale of the company will automatically provide enough retirement income.
Match Contributions to Business Cash Flow
For small business owners, retirement contributions should reflect the realities of running a business instead of following a rigid savings schedule. Revenue can rise and fall throughout the year, especially for seasonal businesses, so contribution levels may need to be reviewed as cash flow changes. Owners also need to account for payroll obligations, business expansion, debt repayment, and emergency reserves before committing excess cash to retirement savings. During a strong financial period, increasing contributions may be practical, while slower periods may require a more cautious approach to preserve working capital. Building an adequate cash reserve can also help prevent an owner from reducing long-term retirement savings because of an unexpected business expense.
Take Advantage of Tax-Advantaged Saving Opportunities
Eligible small business retirement plans can offer tax advantages, but the precise treatment depends on the plan and circumstances. The IRS notes that SEP, SIMPLE, and qualified plans can provide tax-favored retirement savings.
Review the Strategy Regularly
Annual reviews are key as the business grows, employees are added, profits change, and the owner’s retirement date approaches.
How to Choose the Right Small Business Retirement Plan
Do consider:
- Number of employees
- Business structure
- Annual profitability
- Consistency of cash flow
- How much the owner wants to contribute
- Whether employees will contribute
- Employer contribution requirements
- Administrative complexity
- Investment choices
- Plan fees and service-provider costs
The IRS recommends comparing the features of different retirement-plan options when selecting a solution for a small business.
Don’t Overlook Retirement Plan Administration and Fiduciary Duties
When it comes to a retirement plan, also consider:
- Plan administration.
- Recordkeeping.
- Employee communications.
- Investment oversight.
- Plan documents.
- Compliance responsibilities.
- Working with third-party administrators or retirement professionals.
The DOL emphasizes that fiduciary responsibilities can apply to individuals who exercise discretion over plan management or assets. It also recommends carefully selecting and monitoring retirement-plan service providers.
Common Retirement Planning Mistakes
These are the common mistakes that small business owners make:
- Waiting until the business is mature before saving.
- Assuming the business sale will fund retirement.
- Choosing a plan based only on tax benefits.
- Ignoring employee participation.
- Failing to review fees.
- Neglecting plan administration.
- Keeping too much personal wealth tied to the business.
- Not updating the retirement strategy as the company grows.
Building a Long-Term Retirement Strategy
Step 1: Establish a retirement income target.
Step 2: Assess current personal and business assets.
Step 3: Review available retirement-plan options.
Step 4: Select a plan aligned with the business structure and workforce.
Step 5: Establish a contribution strategy.
Step 6: Review investments, costs, and administration.
Step 7: Reassess the plan annually.
Conclusion
Retirement planning for small business owners is not simply about selecting an account. It involves coordinating personal savings, business cash flow, employee benefits, taxes, investments, and eventual business succession.
Compare the options with a qualified financial, tax, or retirement-plan professional.
