Retirement Accounts for Small Business Owners

There are a few different options when it comes to retirement accounts for self-employed or small businesses. Each one has positives and negatives depending on your specific business type. There is also levels of complexity in setting them up and staying in compliance with regulations. Without further adieu, here are some options.

You have probably heard the term IRA before but maybe you didn't know is that it is an uber-complex acronym that stands for Individual Retirement Account. Here are some pros, cons, and details on investing in one. 

Pros - easy to setup. These accounts are not set up by individuals, not an employer. Contributions are made from your personal income (not from taking out of your paycheck. A Traditional IRA is tax deferred (you don't pay any tax now, you pay the tax when you withdraw in retirement) and a Roth IRA is tax exempt (you pay the tax now then don't even have to pay tax again). IRA providers typically have a lot of options to fit the needs of unique individuals. Roth IRAs are not subject to Required Minimum Distributions (RMDs). You can withdraw any contributions (not earnings) from a Roth at any age as long as your account has been open for 5 years. 

Cons - The max contribution limit per year is lower than other options (For 2023, $6,500, $7,500 if you are 50 or older). There is an income limit to getting the tax advantages. If you are over the income limit, you cannot contribute to a Roth IRA and your Traditional IRA contributions are not tax deductible (meaning you have to pay tax on them). Income limit  you cannot exceed for 2023 is $153,000 for filing single, $228,000 for married filing jointly.  Traditional IRAs are subject to RMDs. You cannot withdraw earnings from a Roth or any amount from a Traditional IRA until you are 59 1/2.

Other notes: there is a way to contribute even if you are over the income limit by using a Backdoor Roth IRA. This involves contributing to a non-tax deductible Traditional IRA and then immediately converting it to a Roth IRA. It is a sort of loophole in the system and is completely legal. 

A SEP IRA is a great options for those who are self employed or business owners with few or no employees. The key reason to think twice if you have employees is that the IRA requires that contributions for employees must be an equal percentage of their compensation as your own, meaning you contribute 25% of your salary to your account, you must do the same for any eligible employees. 

Contribution Limit - the lesser of 25% of income or $66,000 (as of 2023).

Pros - Contributions are tax deductible, including those made to employee accounts. Contributions are made solely from the employer, not the employee. High contribution limit. Easy to set up and minimal ongoing administration. You can contribute to a SEP AND a Traditional/Roth IRA (contribution limits are separate). You don't have to contribute every year. Flexibility on contributions. Prior year contributions can be made up to the tax filing deadline. Contributions are vested immediately (fancy term to mean you can take the investment with you if you leave the company). 

Cons - No catch up contribution for those 50+. They have Required Minimum Distributions (RMDs). Must wait to withdraw until 59 1/2 unless they meet early withdrawal exception. Must create a formal written agreement to set up (IRS Form 5305-SEP).  

Other notes: The contribution flexibility can a benefit for business who have variability in their income by year. This means you can wait to see how you ended the year before making your contribution as long as it is before the tax deadline. 

A SIMPLE IRA is a common choice for small businesses due to, as the name implies, the simplicity of setting up an account. 

Pros - easy to set up and has minimal ongoing maitenance. Does not have much, if any, startup costs. Paperwork needed to be filed to IRA is easy to understand. Employer contributions are tax deductibe. No annual tax filing requirements. Typically allow for many options for funds to invest in. Roth option is available. Employees may have the option to choose account provider. Contributions are vested immediately (fancy term to mean you can take the investment with you if you leave the company). 

Cons - cannot have more than 100 employees. You must offer the option to invest to any employee making at least $5,000 in either of the prior 2 years or are expected to make $5,000 this year. Employer is required to make a contribution to employee accounts. This can either a 2% contribution regardless of if employees contribute or a 3% match of employee contributions. Contribution limit for employees is $15,500 ($19,000 for 50+). Contributions must be made through salary deferrals. Has Required Minimum Distributions (RMDs) at IRS designated age. 

Other notes: We do several of these at my firm. Keep in mind that contributions are through salary deferral and be sure to look into how that will work with your payroll. 

I am sure you have heard of this accounts as it is the retirement account of choice for many large corporations but you might not have known a version of it can be utilized for business owners with no employees. To be clear, you must not have any other employees to qualify for this type of plan (not including a spouse). 

Contribution Limit - $22,500

Pros - can have a Roth option. Regular contributions are tax deductible and tax deferred. Contributions are made by employee through salary deferral. Can have an employer match up to 25% of salary and cannot exceed maximum (check IRA for current max). The contribution limit is highest of the options mentioned here. 

Cons - more complex to set up and maintain. IRA has more regulations are this type of account. Cannot withdraw before 59 1/2 without penalty (unless exceptions met). Typically have fewer fund options to invest in. Can be more expensive than other options. No ability to take a loan. Has Required Minimum Distributions (RMDs) at IRS designated age. 

Other notes: This option has the most complexity and cost but also has the highest contribution limit. 

Keep in mind that retirement plans can come with a certain amount of complexity and maitenance that can take time away from running your business. It can be helpful to get guidance from a financial professional to better understand a plan for you.