Small Business Owners Guide to Saving for Retirement

General

In this guide, you’ll learn:

  • 5 retirement savings tips for small business owners
  • 5 retirement plan options for small business owners

As a small business owner, you take full responsibility for your present-day finances – and your future finances. While an employee may get help from their employer with retirement savings, you’re on your own as a small business owner.

Around half of Americans are at risk of not having enough money for a comfortable retirement – this guide will help you join the other half.

5 Retirement Savings Tips for Small Business Owners

Here are 5 retirement savings tips for small business owners:

1. Start Today

You may have heard the phrase “compound interest is the 8th wonder of the world,” attributed to Albert Einstein. While Einstein may or may not have made that statement, there is little debate that compound interest is fantastic for investors. By starting early, you have a good chance of ending up with a nice nest egg – even if your contributions are modest. The person who waits until a few years before retirement, on the other hand, is facing an uphill battle to fund a comfortable retirement.

2. Automate Your Savings

As a small business owner, you have a lot on your plate and make many decisions. So, you don’t want to be thinking about your investments every month. With this in mind, it’s essential to automate your retirement savings, possibly based on your business profits.

Automating your savings makes it easier to avoid altering your contributions based on emotions, which has gotten countless investors into trouble throughout history.

3. Create a Target

By figuring out how much you need for a comfortable retirement, you can work backward and determine your monthly contributions to reach that number. It’s impossible to pinpoint future market returns, but it’s possible to make projections – the key is to be conservative. After inflation, the average long-term stock market return is around 7-8%. While it’s possible to have an all-stock portfolio, you may want to include bonds and other investments to decrease volatility. So, your expected returns are likely to be less than 7-8%.

To calculate expected returns, you should talk to a Certified Public Accountant (CPA) or financial planner. A professional can also help you determine your target nest egg. The 4% rule suggests that retirees can safely fund a 30-year retirement if they withdraw 4% of their retirement funds each year; based on this rule, an amount equal to 25 times your expected annual expenses in retirement is enough to fund your retirement. While the rule has value to investors, it’s a bit of an oversimplification – your “safe percentage” varies based on asset allocations and projected returns.

4. Increase Contributions with Increased Profits

As a small business owner, your goal is to increase profitability over time. While there’s nothing wrong with enjoying the fruits of your labor the same year you earn the money, you should set aside some of that money for your investments.

There are a couple of ways to do that:

  1. Invest a fixed dollar amount each month, subject to annual review. Say you invest $1,000 a month in 2022, but your profits double by the end of the year. You may decide to (at least) double your contributions in 2023.
  2. Invest a percentage of your business profits. You can opt to invest a percentage of your monthly profits – this may be the right option if your net income fluctuates a lot on a month-to-month basis. Say you opt to invest 10% of your profits. If you earn $10,000, you would invest $1,000. But if you earn $15,000, you would bump your contribution to $1,500.

Besides retirement, here are a few other ways to invest your small business profits.

5. Keep an Eye on Investments

It’s a good idea to monitor your investments quarterly or annually so that you can make changes before it’s too late. While changes could mean changes in investment strategy, the safer bet is to make changes in contributions, as there is no free lunch with investments.

For example, you are 52 years old and have 25% of your target nest egg. You hope to retire at 62 years old. In this case, you should seriously consider increasing your retirement contributions.

5 Retirement Plan Options for Small Business Owners

So, you’re ready to start saving for retirement. The next step is to pick a retirement savings plan. Here are 5 retirement plans for small business owners:

*Please note that the information in this section is accurate to the best of our knowledge. But you should double-check the details on the IRS website before investing in any plans – particularly if you are reading months or years after this guide was published.

1. Traditional IRA

With a traditional individual retirement account (IRA), an individual can contribute pre-tax dollars to a retirement account. The money grows tax-deferred until the individual makes retirement withdrawals, when taxes are levied (at their ordinary income tax rate).

You can contribute up to $6,000 per year to a traditional IRA account if you are under 50 years old. If you are 50 years old or above, you can contribute $7,000 each year. You can start taking distributions at 59 ½, and you must begin taking required minimum distributions beginning after age 72.

The traditional IRA is an excellent option if you’re looking for a simple way to save a modest amount of money for retirement, and you expect your tax rate to dip when you are retired.

2. Roth IRA

A Roth IRA has the same contribution limits as a traditional IRA – $6,000 if you are under 50 and $7,000 if you are 50 or above – but it is different in many other aspects. The contributions are not tax-deductible, but they grow tax-free, like the traditional IRA contributions. And in exchange for paying taxes upfront, you can make tax-free withdrawals from the account.

With a Roth IRA, you can withdraw your contributions at any time, tax-free, since you already paid taxes on the money. But you can’t take profits before the age of 59 ½ without being subject to a 10% early withdrawal penalty. So far, the age-related treatment is similar to the traditional IRA, but here’s an advantage with the Roth IRA: there aren’t required minimum distributions – you can leave the money in your account as long as you want and possibly pass it to your heirs.

There are income limitations with Roth IRAs. If you are single and making $129,000+ (in 2022), your contributions gradually phase out. The number for married couples is $204,000+.

The decision between a traditional IRA and Roth IRA usually comes down to a few things:

  1. Income limits: the traditional IRA doesn’t have income limitations, unlike the Roth IRA.
  2. Required minimum distributions: do you want to leave the money in the account into your 80s? In this case, a Roth IRA makes more sense.
  3. Taxes: if you expect your tax rate to be lower in retirement, a traditional IRA may be the way to go. The Roth IRA might make sense if you think you’ll have a higher tax rate when you’re retired.

As with everything in this guide, it’s best to talk to a qualified professional if you’re uncertain about the best move for your situation – the stakes are high, so it’s well worth it to pay for a consultation.

3. Solo 401(k)

Are you a self-employed individual with no employees? If so, the solo 401(k) is an option. If not, you should skip to the next plan.

The solo 401(k) has a contribution limit of $61,000, and you can make a $6,500 catch-up contribution if you are 50 or older. So, this retirement plan is an excellent way for highly profitable self-employed people to fund a comfortable retirement.

You make contributions with pre-tax dollars and pay taxes when you withdraw the money after you’re 59 ½ years old.

Here is some more info on the Solo 401(k).

4. SEP IRA

A small business owner with employees can use the Simplified Employee Pension (SEP) IRA. But it’s better suited for small employers with few or no employees because you also have to contribute on behalf of eligible employees – and those contributions must be equal to the ones for your account as a percentage of compensation. So, if you save 10% of your own compensation, you also have to contribute 10% of the eligible employees’ compensation to their plans. There’s a good chance that some of your employees are eligible, but you should check the eligibility requirements.

The contributions can be made with tax-deductible dollars, and your SEP IRA contribution limit is $61,000 or 25% of compensation, whichever is less. To qualify for penalty-free distributions, you have to be at least 59 ½ years old, and there are required minimum distributions starting at age 72. You have to pay taxes on distributions.

5. SIMPLE IRA

Small businesses with fewer than 100 employees can use the Savings Incentive Match Plan for Employees (SIMPLE) IRA. The appeal of the SIMPLE IRA is, as the name suggests, simplicity in setting up the plan. However, the contribution limits are on the lower end: $14,000 if under 50 and $17,000 if 50 or above.

While you have to contribute to your employee accounts with the SIMPLE IRA, those contributions are limited to 2-3% of each employee’s compensation, depending on the situation. So, the SIMPLE IRA may be preferable to the SEP IRA if you have a lot of employees.

A SIMPLE IRA has similar tax advantages to a Traditional IRA. Here is some more info on the SIMPLE IRA.

The Bottom Line

As an entrepreneur, you want your hard work to lead to a nice retirement. By using tried and true investment strategies and using the right type of plan, you can generate plenty of retirement income. But to reiterate: it’s a good idea to talk to a qualified professional before making any decisions.

While investing in the market is an excellent way to fund your retirement, your small business cash flow could also help cover your personal expenses into your golden years. Pradeep Saini is developing a 10-unit shopping strip and said, “This is going to be my retirement, and this is going to be the biggest project I have ever worked on.” But he needs financing to make the project a success – financing that he will get from Biz2Credit.

Learn how Biz2Credit can connect you with straightforward funding made for your business.

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