Small Business Retirement Plans: How to Choose the Best Strategy for Your Needs

Small business owners are important drivers of economic growth. They help create 1.5 million new jobs each year and are responsible for 64 percent of new jobs created in the US as per a report by the Small Business Administration. Small businesses also employ 47.1 percent of all private sector employees. It goes without saying that they are an important component of the economy. However, it’s not an easy job. The hard work that goes behind running a small business can be taxing. Small business owners often find themselves alone dealing with various challenges like finding the right funds for growth and expansion, hiring suitable employees, purchasing the latest machinery, advertising and marketing their products and services, product sales, and so much more. Not only this, but small business owners are also responsible for their personal growth and future security along with those of their employees.

If you run a small business, you do not have a salary to bank upon. You are responsible for creating an income for yourself. The same can be said for your future security and retirement savings. There is no option to rely on an employer-sponsored retirement plan where your employer matches your contributions. Since you are your own employee, saving for retirement falls entirely on your shoulders. Moreover, since businesses can have erratic earning patterns where you can earn an enormous profit one month and have little to no sales the next, saving in a stable retirement plan for your future needs becomes imperative.

Having a retirement plan is also important for your employees. Businesses that offer their employees retirement plans can help see better performance and productivity. The employee also feels a sense of loyalty to the company that further benefits the business. Hence, having a business owner retirement plan is extremely necessary for the employer as well as the employee. To guide you through this process, consider engaging the services of a financial advisor, who can set up a retirement plan for you and your employees to help secure your financial future.

Why should small business owners have a retirement plan?

If you are a small business owner, here are some reasons why you should pay attention to retirement planning:

• You have little financial security: Small businesses contribute a lot to the economy, but they are extremely tricky to run. Although they are often backed by new and creative ideas, their reception in the market can be unpredictable. Moreover, with increasing globalization and the world becoming a smaller place thanks to the Internet, customers have a wide range of products and services to choose from. And while the Internet makes it easy for you to reach more customers, it also exposes you to more competition. Surviving in a market full of innovation and new players every day can be tough for small businesses. A new brand can take over your company’s place anytime. There is little to no security, and the future can be grossly uncertain. Hence, it becomes extremely important to be prepared for any financial contingency in the future and have a solid retirement plan in place that safeguards your retired years and offers your employees a safety blanket.


• There may not be a stable income: The upside of having a job is that your salary is stable and constant for as long as you are employed. Unless there is a major global, political, or economic crisis like the great recession or the Covid 19 pandemic, the chances of being unemployed or receiving a salary cut are rare. As a result, your retirement savings always remain consistent when you work for someone else. However, as a small business owner, your earnings can fluctuate. This means that while there can be times when your business does well, there can also be times when you are barely able to sustain your basic expenses. Take the Covid 19 pandemic, for instance. With complete lockdowns for months on end, a lot of businesses were forced to shut down. In such a case, it can be hard to save for the future. And you may end up neglecting your future without a concrete business owner retirement plan in place.


• It can be hard to differentiate between personal and professional needs: It can be hard to draw a line between your personal and professional finances, especially if you are the sole owner of the business. Consciously or unconsciously, most small business owners tend to reinvest whatever profits they earn from the business back into it. They tend to believe that the business itself is their retirement plan and that they do not need to save separately for their golden years. However, for the same reasons as explained above, it is very important to have adequate personal savings outside of your business’s profits to ward off any financial uncertainty or insecurities. Regardless of the profits you earn, you must allocate some to a retirement plan meant for your personal use in retirement.

What are the best retirement plan for small business owners?

If you do not know how or where to start retirement planning, here are some small business retirement plans that can help you:

1. SIMPLE IRA for small business owners: Short for Savings Incentive Match Plan for Employees Individual Retirement Account, a SIMPLE IRA is an employer sponsored retirement plan for small business owners. A SIMPLE IRA can only be used by businesses that have 100 or fewer employees. In addition to this, all the employees should be earning at least $5,000 per year. As of 2021, you can contribute up to $13,500 in a SIMPLE IRA. The contributions are made from pre-tax income. If you are 50 or older, you can add another $3,000 as a catch-up contribution and contribute a total of $16,500 in a year. The employers can match the employee contributions in a SIMPLE IRA. This can amount to 3% of the employee’s compensation. Employers can also put a 2% non-elective contribution for every eligible employee’s compensation of up to a total of $285,000 even if the employee does not contribute themselves. The money contributed to a SIMPLE IRA grows tax-deferred and is taxed when it is withdrawn in retirement. Considering that most people have a lower taxable income in retirement than in their working years, this can be a great retirement plan option to save money.

Setting up a SIMPLE IRA is simple, just like the name suggests. The paperwork is minimal and a lot less compared to setting up a 401(k) retirement account. A SIMPLE IRA is also a cost-effective option, and the charges of opening and maintaining the account are quite low. And there are no filing requirements with the Internal Revenue Services (IRS) for the employer either. Furthermore, small business owners are eligible to get a tax credit to offset the costs of a SIMPLE IRA with auto-enrollment.

However, the annual contribution limits set for a SIMPLE IRA are a lot lower than other similar retirement accounts. Over a period of time, this can severely hamper your retirement savings. Another shortcoming of a SIMPLE IRA is the absence of a Roth variant. The withdrawals taken before the age of 59.5 also trigger a 10% penalty. And withdrawals made within the first two years of investing are met with a 25% penalty. So, the account lacks liquidity in the short term.

2. SEP IRA for small business owners: The Simplified Employee Pension account is another option available to small business owners. It is a lot like a traditional IRA, with the exception of employer contributions that are missing in a traditional IRA. The SEP IRA can be set up by an employer as well as a self-employed individual. So, it can be used by owners as well as employees. You can contribute your pre-tax dollars to a SEP IRA. The investments grow tax deferred and are taxed when withdrawn in retirement, much like the SIMPLE IRA. The contributions are also tax-deductible. However, there are certain eligibility criteria that you have to meet to open a SEP IRA, such as mentioned below:


• All participating employees should be 21 or older
• All participating employees should have worked for at least three of the past five years
• All participating employees should have earned at least $600 in the past year

A SEP IRA can offer higher contribution limits than any other IRA. As of 2021, you can contribute up to $58,000 in a SEP IRA in a year. However, the annual contribution limit cannot exceed 25% of the total salary. The employer can also only contribute up to 25% of the employee’s salary. Since the annual contribution limit is already high enough, there is no catch-up contribution for people over the age of 50. There is also no Roth variant for the SEP IRA. In addition to this, you also cannot borrow any money from your SEP IRA and withdrawals before the age of 59.5 attract a penalty of 10%. However, the SEP account is owned and controlled by the employee and not the employer, and therefore makes for a better pick for the employee.

3. Traditional and Roth IRA for small business owners: If you wish to save for only your own needs, you can consider investing in an IRA for yourself. A Traditional and Roth IRA can both be excellent choices to invest in. If you want to pay tax now and enjoy tax-free withdrawals, you can consider opening a Roth IRA. However, if you want to pay tax in retirement and grow your investments tax deferred, you can invest in a Traditional IRA. The decision can be made based on your present taxability and how you foresee your retirement, and a financial advisor can help you make the right decision.

You can easily set up an IRA. There is no age limit to open an IRA as long as you have a taxable income. You can open an account with a bank or a brokerage firm. The process is quick and may only take a few minutes of your time. Moreover, you are in charge of your investments and can manage the account as you like, unlike a 401(k) where you are only a participant, and the employer takes charge of most decisions. As of 2021, you can contribute up to $6,000 per annum with a catchup contribution of $1,000 ($7,000 in total) for people over the age of 50. Similar to other retirement accounts, you are eligible to make withdrawals only after the age of 59.5. Early withdrawals incur a 10% penalty. In the case of a traditional IRA, you also have to start taking Required Minimum Distributions (RMDs) starting from the age of 72.

4. Solo 401(k) for small business owners: A solo 401K) retirement account is a special account designed for the owners of a business and their spouses. The solo 401(k) is limited to businesses with no employees other than the spouse. This can include sole proprietors, freelancers, independent consultants, etc. Opening a Solo 401(k) is quite simple and straightforward and can be done with the help of a broker. The contributions are made from your pre-tax dollars and taxed in retirement. The contribution limit for a Solo 401(k) in 2021 has been set at $58,000 per year. There is also a catch-up contribution of $6,500 for those 50 or older. There are two ways to contribute in a Solo 401(k). The first is to assume you are an employee, and the other is to contribute as an employer. If you contribute as an employee, you can contribute up to $19,500 or up to 100% of your compensation, whichever is lower. And there is a catch-up contribution of $6,500 for those 50 or older. If you contribute as the employer, you can make a profit-sharing contribution of up to 25% of your compensation or the net self-employment income.

The Solo 401(k) offers the traditional as well as the Roth variant, so you can make a choice as per your taxable income. If you pay more tax now, you can opt for the Roth variant and vice versa. However, regardless of what you choose, you can only make withdrawals after the age of 59.5. Otherwise, you will have to pay a 10% penalty.

To summarize

There are many retirement plans for small business owners to choose from. But it is important to choose the one that benefits you the most. Pay attention to the features, contribution limits, expenses, ease of operation, control, etc., that each retirement account offers you and your employees, and then make a decision. Also remember, that as a small business owner, it is equally important to keep your employees happy and satisfied by offering them a good retirement plan as it is for you to save for your own future requirements. So, do not neglect either and aim to strike the right balance.

If you are still not sure which option is ideal for you, a professional financial advisor can help you select the best retirement plan for small businesses.