With the many demands placed on business owners, these individuals usually aren't focused on their retirement. Many small-business owners often trade tomorrow's retirement planning for today's successful company. Owners do imagine their comfortable retirement, but often forego saving for retirement in order to keep their businesses thriving in the moment.
Here's where the fatal flaw lies in the retirement plans of many small-business owners: After pouring countless hours into building the business, their strategy usually entails either having enough incoming revenue by they time they retire to offset any savings, or hope that they can sell their business for an amount significant enough to fund their golden years. Often times many business owners are so sure this will happen that they don't bother to make any contributions to the variety of retirement and investment accounts out there. In a sense, they're putting all of their eggs in one basket, and more often than not, they can't afford to retire when the time comes.
The good news is, when you're self-employed you have more choices about when to retire and how to save for retirement. With a little planning and consistent contributions to the right accounts, you can still put away a substantial nest egg. Here's how you can begin.
1. Analyze your business and retirement strategy. The first step in setting up a retirement-saving strategy is to analyze your business. Does the business have sufficient cash flow to put the extra money aside for retirement? If it does, start immediate contributions to the variety of options, many of which are listed below. If it doesn't, you're most likely going to have to wait.
2. Fit your company's needs. When choosing a retirement plan, you must also examine the following things:
- the best investment option for you
- your business and employees (if applicable)
- the maximum amount of possible yearly investment
- set-up difficulty
- administrative complexity and administration costs
- tax ramifications
The tax ramifications are extremely important to examine, because with the right retirement plans, you can reduce and streamline your tax obligations. For example, putting savings in a SEP IRA can reduce the taxes you pay today, but a Roth IRA lets you pay taxes upfront so that you can withdraw funds tax-free upon your retirement. The bottom line is to consider retirement funds not just for what it can do for your retirement, but how it fits within your business plan and to help your current tax situation.
3. No employees? Consider the new self-employed 401(k) plan. Flexibility is the main highlight of the new self-employed 401(k) plan or the solo 401(k) plan. This plan was created in 2001 tax legislation and is geared toward self-employed individuals who have no employees or who work with their spouse. The plan allows the worker to contribute a percentage of income and adds an amount parallel to the voluntary contribution that workers who are employed can put into conventional 401(k) plans. The mechanics of setting up a solo 401(k) plan are also a lot less cumbersome than other small-business plans, and the administrative costs are relatively low. The largest disadvantage of the plan is that the limit for the total of the contributions can't exceed $44,000.
4. Have employees? Consider the Simplified Employer Pension plan (SEP). SEP plans are an easy and low-cost retirement plan that can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. Under a SEP, an employer contributes directly to traditional individual retirement accounts for all employees and to themselves.
With a SEP, there are minimum administrative burdens, including few paperwork requirements, and little or no startup costs. Therefore, not only are SEP plans inexpensive to establish, but also inexpensive to maintain. These plans also have a higher contribution limit when compared to the traditional IRA. The good thing is, there are no minimums in terms of your contribution amount. Employer and employee contributions aren't mandatory every year, so you can vary your contributions each year based on the amount of extra money available to save, and there are many tax advantages to the plan.
Another benefit of the SEP plan are the tax advantages. Contributions are tax-deductible, and your business pays no taxes on the earnings on the investments. Also, the small-business owner may be eligible for a tax credit of up to $500 per year, or each of the first three years for the cost of starting the plan.
5. Lead by example: Inspire your employees to contribute to retirement with a SIMPLE 401(k) plan. The SIMPLE 401(k) plan was established in 1997 so that small businesses could have an effective, cost-efficient way to offer retirement planning to their employees. This plan is a cross between the SIMPLE IRA and the traditional 401(k) plan, and is available to organizations with fewer than 100 employees. Employees who are 21 years or older, and have been employed for at least a year, can be eligible to participate in this plan.
Employers have two options for contribution to this plan. The first contribution method encourages employee participation by requiring the employer to match all employee contributions up to 3 percent of their salaries, with a $6,000 limit. The second option is a fixed contribution plan. In this case, employers pay a flat 2 percent of the worker's salary. This contribution is required for all participating employees, regardless of whether the employees contribute on their own.
The advantages of the SIMPLE plan is that it's less expensive compared to the traditional plan and has lower maximum employee contribution limits. The advantage to the employee is that there are mandatory employer contributions, and employer contributes made to the plan are automatically full vested.
6. Consider the larger picture. Investments are just one tool of the financial planning process. It's important to make sure other preparations are made, such as will planning, long-term care medical insurance and establishing life insurance to increase the likelihood of a comfortable retirement. You also must carefully analyze your time horizon and risk tolerance, and invest retirement contributions appropriately and consistently. A complete analysis of one's objectives, expected time until retirement, and tolerance for the ups and downs of the market is a crucial part of the planning process. Seek advice.
Make sure to enlist the help of an accountant and financial advisor. There are plenty of resources on the internet, and numerous books dedicated to the subject matter, but a financial advisor will be able to analyze your particular situation and guide you in the right direction.
J. Graydon Coghlan is president of San Diego-based Coghlan Financial Group, LLC, a financial advisor firm that specializes in financial, retirement and estate planning.