Those who are self-employed or who own a small business need to save for their own retirement. They need to take the initiative and get started. Unlike with a larger employer who offers a retirement plan, you are responsible for doing this yourself to ensure that you have sufficient assets available to you when you retire.
For California Businesses:
California small businesses that don’t offer a retirement plan for their employees may be forced to register for the CalSavers program. Companies with 5 to 50 employees have until June 30 to enroll. The deadline for larger companies to enroll has passed, but they may still be able to register and avoid penalties. While the CalSaver program is well-intentioned, most companies can do better for the owner and the employees by working with a financial advisor to establish a plan that better meets their needs. This might be a small business 401(k), a SIMPLE IRA or even a SEP-IRA.
Here is a look at some of the retirement savings options to consider.
IRAs are available to anyone who has earned income. You open an account, contribute money and start investing. Some key points about IRAs:
- Contribution limits for 2021 and 2022: $6,000 plus a $1,000 catch-up for those 50 and over.
- Available as traditional or Roth IRAs.
- There are income limitations for Roth contributions and for pre-tax contributions for those who are covered by a workplace retirement plan.
- Not available for employees.
- Money grows tax-deferred in a traditional IRA and tax-free in a Roth.
- Withdrawals are tax-free from a Roth IRA if certain conditions are met.
Available for business owners, their spouses involved in the business and business partners.
- Employees who do not meet the above criteria cannot participate.
- Contribution limits are the same as a workplace 401(k).
- The business can make profit sharing contributions up to 25% of your compensation up to a maximum of $61,000 and $67,500 for those who are 50 or over in 2022.
- Easy to open at most major custodians, paperwork is minimal.
- Roth options may be available depending upon the custodian.
Available for the self-employed plus businesses with employees.
- Contributions are made by the employer only, there are no employee contributions.
- There is no Roth version available.
- A SEP-IRA can be started and funded up to the tax filing due date for the company, including extensions.
- Contributions are made as a percentage of owner and employee compensation, up to 25%. Business owners must contribute the same percentage to any eligible employees as they do for themselves, making this potentially an expensive option for a business with employees.
- The maximum contribution for 2021 is $58,000 for 2021 and $61,000 for 2022. There are no additional contributions for those who are 50 or over.
- The contributions offer a tax break to the business, including sole practitioners.
The SIMPLE IRA is available to the self-employed and to businesses with up to 100 employees.
- Employee contributions are tax deductible.
- Employers must make a minimum contribution to each employee’s account of up to 3% of compensation or a flat 2%.
- The maximum employee contribution is $14,000 for 2022 with an additional $3,000 available as a catch-up contribution for those 50 or over.
- SIMPLE IRAs require minimum paperwork and were designed to be an easy option for small businesses.
- There is no Roth option available with a SIMPLE IRA.
- A rollover from a SIMPLE IRA will be assessed a steep penalty if the rollover is made within the first two years since an employee has made their first contribution, unless the rollover is to another SIMPLE IRA plan.
- Employer contributions and costs of running the plan are tax deductible to the company.
Small Business 401(k)
There are a number of providers that offer 401(k) plans tailored to smaller companies.
- These plans offer the chance for the company’s employees and the owner to build retirement savings.
- The plan can offer auto-enrollment whereby each employee is automatically enrolled in the plan with contributions to a QDIA (qualified default investment alternative). This ensures that each employee is saving something and can help the plan avoid failing its annual non-discrimination testing, which could limit the ability of the owner and other highly compensated employees to contribute the full amount to the plan.
- Safe harbor plans provide a minimum employer contribution to all employees. In exchange for this, the employer gets a pass on its annual plan testing.
- Some small business plans do not offer great investment options and may be quite expensive for the participants and for the employer.
- The employer receives a tax deduction for any contributions to the employees as well as any out-of-pocket costs associated with running the plan.
- A Roth option can generally be added to the plan.
Defined Benefit Plan
A defined benefit plan is a traditional pension plan. DB plans can be implemented for the self-employed as well as for a small business.
- Defined benefit plans offer a set retirement benefit for business owners and employees.
- They are funded by the employer.
- The plan typically offers a benefit based on years of service and compensation.
- The employer receives a tax benefit for contributions to the plan and for the costs associated with administering the plan.
- Defined benefit plans can be very expensive for the employer, including funding requirements, the need for an actuarial valuation and other expenses.
- Funding the plan is mandatory, defaulting on the plan obligations could put the company out of business.
Andrew Hutcheson, SVP and Branch Manager of Wedbush in Pasadena, CA says, “The decision to implement a company retirement plan is very important. It is imperative that you not rush into the decision as it can be hard to make changes once a plan has been started. A financial advisor who specializes in retirement plans should be consulted from the very beginning.”
He adds, “If the advisor doesn’t have the proper expertise, then they might not be informed regarding all of the nuances that the changing regulatory environment can have on the different plans. From Solo 401k’s to a SEP-IRA and SIMPLE IRAs, one has to be very cognizant of the limitations if you grow or want to terminate the plan. This decision can have long-term implications on retention and future growth.”
Questions about the best retirement plan option for your situation? Contact your Wedbush financial advisor for help and advice.
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These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice.