One of the biggest concerns I hear from my clients is their fear that they will “outlive their money.” Everyone has seen the advertisements and web sites offering to calculate how much money you need to save to be able to replace your current income when the time comes for you to go to the office one last time. The savings goal often seems unattainable, especially if people wait until their 40’s or 50’s to start saving. If you are a young worker – start saving now! If you are over 50 many types of retirement accounts allow you to make “catch-up” contributions.
One of the best ways to be able to reach your individual retirement savings goal is to take advantage of a tax favored retirement savings plan. If you are employed by a medium to large business, most likely your employer offers a plan in which you have the opportunity to participate. Many of these plans allow you to save pre-tax dollars that allow the earnings to grow tax-free until you withdraw the funds during your retirement years. Other plans allow post-tax dollars to grow tax-free and even escape being taxed when withdrawn.
But what if you are self-employed or starting a small business? The complexity and administrative cost of some types of retirement plans don’t make them a good fit for a self-employed individual.
However, several types of retirement plans are designed with self-employed and small business owners in mind. The key is finding the plan that works for your individual situation and then making sure you are taking full advantage of the current and future tax savings and the opportunity to provide for your future retirement needs. Here are some, but not all, of the plans to consider:
- Simplified employee pension (SEP) plan
- SIMPLE IRA plan
- SIMPLE 401(k) plan
- Individual 401(k) plan
- Keogh plan(a qualified retirement plan established by a self-employed individual or partnership)
A SEP plan allows small businesses to experience similar advantages to a “qualified” retirement plan by making contributions (up to $52,000 in 2014) to SEP-IRA accounts for the owner and the employees. SIMPLE plans are available to businesses with 100 or fewer employees, and allow an IRA account for each employee and matching contributions by the employer. The employee can contribute as much as $12,000 ($14,500 if over age 50) to a SIMPLE IRA. SIMPLE 401(k) and Individual 401(k) plans allow similar features to the popular 401(k) plans offered by larger businesses with employee contribution limits of $17,500 ($23,000 if over age 50).
One factor that will determine which type of plan is right for you is the entity structure of your business. Whether you are operating as a sole proprietor, a single member LLC, a 100 percent owned S corporation or a C corporation will influence your decision. Whether you have employees or not and the age and compensation level of your employees are also factors to consider.
Most plans allow flexibility from year to year in the funding level, allowing you as a business owner to contribute more to the plan in a profitable year and back off in a year where cash flow is more challenging. Your comfort level with a mandatory contribution each year can also be taken into account in deciding which type of plan to choose for your business. Some people are comfortable with a required minimum contribution each year while others prefer a plan where contributions are entirely discretionary from year to year.
Don’t let complex rules and a myriad of choices overwhelm you and prevent you from moving forward with a retirement plan. A retirement plan consultant who is knowledgeable about the available plans can help guide you to the plan that best meets the retirement savings goals for you and your employees.
Mary Lu Foster, a director with CliftonLarsonAllen, provides tax planning, accounting and advisory services to individuals and businesses in a variety of industries. She specializes in working with professional service firms and other closely held business clients.