Retirement Plans for Really Small Businesses

Are you a solopreneur?  Apparently, 35% of the work force are solopreneurs with that number expected to climb to 50% in the next three years.  I count myself within that group, though I’m still working hard to get bigger.  As a financial planner, I know how important it is to save for the later stages of my life, but I remain concerned about using money for investing in my business as well as handling my day-to-day living expenses.

Many solopreneurs believe that they can only contribute to a traditional or Roth IRA (or some combination thereof).  That’s not true.  Yet others consider opening “Solo” 401(k) plans, so they can make greater contributions than in IRA accounts.  But the costs to open and maintain a plan according to regulations may not make it the best option.  So, if you are an individual business owner, how can you save lots more than the $5,500 IRA limit ($6,500 if you’re over 50) while keeping costs low?  We invite our entrepreneurial clients to consider a Simplified Employee Pension often called a SEP plan or SEP-IRA. 

In general, planners recommend that people save 10% or more of their income, and if you make between $80,000 and $275,000 per year, a SEP may be the easiest and most cost-effective way for you to save the 10% to help you build up your long-term retirement savings. 

Setting up a plan is easy.  If you have no other plan in place for your business, your tax advisor can give you a form 5305-SEP to begin your plan.  You, as business owner, get to decide how to determine eligibility for your plan, subject to certain parameters.  When you make your contributions, you decide where to open your SEP accounts and how you want to invest the money in the account.  Here’s the kicker, contributions come directly from your business from business profits and you can contribute up to 25% of your income (subject to a maximum of $55,000 in 2018)!  Talk about superpowering your savings!  As a result, they are tax-deductible, and you can contribute much greater amounts than the $5,500 IRA limit ($6,500 if you’re over 50).  Also, depending on your situation, you may still be eligible to make contributions to a traditional or Roth IRA.

There is a downside however.  If you do eventually have employees, when they become eligible for the plan you will have to make an identical percentage contribution to their SEP accounts as you do to yours.  For example, let’s say that you’ve been making $100,000 per year.  You have been making 10% contributions to your SEP plan.  Now you grow and you’ve hired an employee. Congratulations! However, if you want to continue contributing to your SEP at 10%, you will also have to make a contribution of 10% of your employees’ salary to their SEP once they become eligible.   So, if your employee earns $40,000, you will need to make a $4,000 contribution to their SEP, if you would like to make a 10% contribution to your SEP as well.  If you no longer believe that a SEP is working for your situation, you can terminate the plan at any time and consider using another form of plan that might better serve your needs.  Also, there is no Roth option for a SEP-IRA, so you may not fund a SEP-IRA with after-tax funds.

Typically, we think that SEPs are best for businesses with five or fewer employees.  More than that and you are likely better off with a 401k or other profit sharing plan where employees are responsible for making their own contributions, but this may depend on your goals and the goals of your organization.

If you’d like to learn more about whether a SEP plan is right for you, reach out or call today so that we can figure out what the share of your income you should save.

Were you planning on making an IRA contribution for 2017 when you file your taxes, but would like to put away more than the IRA and Roth IRA limits?  Does a SEP sound like it might help you supercharge your savings?  Reach out and we’ll give you some steps to get started and see how we can help you get your account open so you can make your first contributions with the 2017 tax year.

Russell D. Rivera, CFA®, CFP®, is the Founder and President of Voice Wealth Management (Voice). He considers himself as a Personal CFO and Financial “Therapist” for entrepreneurs, young professionals, and their families. He helps clients make prudent financial decisions regarding spending, saving, investing, and planning while giving a voice to the individual client's financial priorities and experiences. Get in touch with Russell at 646-630-0980 and voicewealth.com.