Personal Finance | August 15, 2018

Own Your Own Business? Are You Saving Enough for Retirement?

Key Points

  • When you own your own business, saving for retirement is even more of a challenge because it's all up to you.

  • Fortunately, there are small business plans that make it easy even for a sole proprietor to boost savings and enjoy significant tax advantages.

  • Saving is a good first step, but investing is the key to really preparing for retirement.

Dear Carrie,

I'm 35 and am the sole proprietor of a small business. I've always been a good saver and have put some money in an IRA every year, but I know it's not enough. What else can I be doing?

—A Reader


Dear Reader,

For a sole proprietor, saving for retirement can be more of a challenge because basically it's all up to you. And it's difficult to put those hard-earned dollars toward the future when there's so much to deal with in the present. But you sound like you're already on the right track because you've started to save. You're lucky, too, that you're realizing this at age 35. Because yes, there's definitely more you can be doing, and the sooner the better.  

A traditional tax-deductible IRA or a Roth IRA can be a good first step, and fortunately, there are other options for small business owners that can help you save even more.

You can start with an IRA

An IRA is an easy place to start. While most people might automatically think of a traditional tax-deductible IRA first, a Roth IRA may be the better choice for someone your age. As you may know, contributions to a traditional IRA reduce your taxable income and earnings are tax-free, but then the tax bill will be due when you take the money out. On the other hand, you fund a Roth IRA with after-tax dollars but both earnings and distributions are tax-free after age 59 ½, as long as the account is at least 5 years old. As a result, a young person such as yourself might benefit by paying the tax now when you’re likely in a lower tax bracket than you might be later in your career.

One big caveat is that both traditional and Roth IRAs have low contribution limits, making it difficult to put away enough money for retirement. In 2018, at your age, you can only contribute $5,500 each year. In addition, you are only eligible to contribute the full $5,500 to a Roth IRA if in 2018 you earn less than $189,000. Contributions to a Roth IRA are gradually phased out for incomes up to $198,999, and not allowed at all after that.

SEP-IRA—easy and flexible

One great option is a Simplified Employee Pension Plan (SEP-IRA), specifically designed for self-employed individuals and small business owners who want to save more and keep paperwork to a minimum. It's easy to open and lets you make fairly high annual contributions. It also gives you the flexibility to vary contributions—or skip them entirely—according to your yearly business needs.

A big plus of a SEP-IRA is that you can sock away a significant chunk of money. The maximum contribution in 2018 is the lesser of 25 percent of your net earnings (equivalent to 20 percent of your net income or your business profit less the deduction of one half of your self-employment tax) or $55,000. While there are online calculators to help, this calculation can be confusing so it's probably wise to get your exact figure from your accountant.

Of course, there are tax advantages, too. Like a traditional IRA, contributions to a SEP are pre-tax, lowering your taxable income. Plus, earnings grow tax-deferred. Withdrawal rules also mirror that of a traditional deductible IRA, so you'll pay ordinary income taxes on withdrawals plus a possible 10 percent penalty if you withdraw money before age 59 ½.  

If you ever have employees, a SEP-IRA must be set up by or for each eligible employee. You'll need to make the same (percentage-wise) contributions on their behalf as you make for yourself. They may be set up with a bank, insurance company or other qualified financial institution. Elective employee salary deferrals and catch-up contributions are not permitted in SEP plans. Employees are responsible for making any investment decisions relating to their SEP-IRA accounts.  

Solo 401(k)—higher limits with a bit more paperwork

Another choice is a Solo (Individual) 401(k)—either traditional or Roth. This plan requires a bit more paperwork but allows even higher annual contributions—100 percent of earnings up to $18,500, plus 20 percent of net self-employment income up to a total of $55,000. If you're 50 or older, you can contribute an additional $6,000 for an annual total of $61,000.

As with a SEP, you can choose to contribute or not according to your business needs. Unlike a SEP, you have the possibility of borrowing against your savings and there are additional filing requirements. One caveat: a Solo 401(k) can only include sole proprietors and spouses. If you ever want to include employees, you'd have to change plans.

SIMPLE IRA—good if you have employees

For the record, if you have employees, a SIMPLE IRA (Savings Incentive Match Plan for Employees) allows both employees and employers to contribute to traditional IRAs set up for employees. It's ideal as a start-up retirement plan for small businesses (up to 100 employees). However, it does have lower contribution limits ($12,500 in 2018 for those under 50) and contribution requirements if you hire employees.

HSA—for healthcare costs and more

While not specifically designed for retirement, you might also consider a Health Savings Account (HSA) as a way to cover both current and future healthcare expenses.

You can open an HSA if you have a high-deductible insurance policy. In 2018, deductibles must be at least $1,350 for an individual, $2,700 for a family. Current annual contribution limits are $3,450 for an individual, $6,900 for a family. Like an IRA, contributions are tax-deductible and your money grows tax-deferred. Withdrawals for qualified medical expenses, however, are tax-free. Money not used for medical costs continues to grow tax-deferred, but would be taxed at ordinary income rates after age 65 (and nonqualified distributions prior to age 65 would be subject to a 20 percent penalty).

Talk to your accountant or advisor, then put your money work

The best choice for you depends on your current situation and your business goals. I suggest you talk with your accountant and financial advisor and get the details. The beauty is that depending on your circumstances you can potentially continue to contribute to your IRA, establish a SEP or Solo 401(k), plus add an HSA if appropriate, maximizing both your savings and your tax advantages. However, to me, the key to making the most of your money is to invest it. And all of these accounts give you investment opportunities.

As a young adult with a long time horizon, you should be able to invest your retirement money in the stock market knowing you can ride out market ups and downs. A reasonable long-term projection would be 6 to 8 percent annual growth for a diversified stock portfolio. That's really the best way to attempt to outpace inflation. On the other hand, any money you know that you will need in the short-term, say in the next two to five years, is best kept in a savings account or CD, protected from market fluctuations.

To get started, talk to a knowledgeable friend or family member, consult with a broker or financial advisor, or look into online, automated portfolio advice available from several financial institutions. As a small business owner, you work hard. By investing as well as saving, you have a chance to make your money work as hard as you do. Best of luck.


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