Author: Elliott Servais
According to a recent Manta survey of small-business owners, 34% don’t offer any type of retirement benefits.
Why is this?
As a small business ourselves, the team at EP Wealth Advisors knows that running your company makes time a precious resource. Employers who aren’t investing in a retirement plan may be missing out on an opportunity to prepare for retirement and the potential saving benefits that come with it.
A retirement plan can be a valuable management tool. It allows you to attract and retain employees and may offer opportunities for tax savings for yourself. Yet despite these advantages, retirement planning remains a mystery to many small businesses.
The Manta survey revealed five primary reasons why entrepreneurs and small-business owners say they haven’t developed any retirement plans.
This is a fair argument to make, especially if you just recently established your business. But once you start creating a bigger name for your company, your expenses also will grow, continuing to compete with the desire to allocate a share of profits to retirement. A common mistake business owners can make is to pay themselves more than what they need, or use their business account for personal expenses. The greatest benefit to starting a retirement plan for your business and your employees is that it may lower your taxable income at both the business and personal levels. A financial advisor from EP Wealth, with the assistance of your CPA or accountant, can examine your finances, organize the paperwork and assess revenue to help you determine if a retirement plan is a good option.
Business owners usually think reinvesting their profits back into their business makes the most sense. Unfortunately, because their biggest asset on their personal balance sheet is their business, what they end up with is a lack of liquidity.
A fellow advisor and I discussed this topic and agreed this might not be the best idea from a retirement perspective. Taking money out of your retirement savings account incurs substantial penalties. You may actually lose money up front.
This type of strategy, which most business owners count on, may involve high risk. You may need to look at different contingencies. For example: What if a recession strikes once again, as in 2008? Your business will need to go through that hardship, and may find it challenging to recover in a timely manner. The main thing to think about is that your schedule for retirement may not coincide with the economic market.
What many business owners also tend to overlook is having a succession plan. Although they plan to sell their business to fund their retirement, they need to consider that there are many contingencies in their personal and work life, and prepare for them. A co-worker of mine had a small-business-owner client who was seriously injured in a car accident and couldn’t operate his business anymore. With no plan for a successor to maintain the value of the business, his wife had to sell it – unfortunately for a value that was very low.
When I hear this from clients, I often ask, “What is your tax plan?” There may be tax-saving opportunities in setting up a retirement plan.
Beyond the potential tax-saving opportunity, having a retirement plan is crucial for you and your company. It can be very valuable to your employees. As for you, having some type of retirement plan will help if any contingencies do occur in your personal and business life.
One of the most distinctive things about business owners is the amount of focus, time and energy they dedicate to their businesses. But life can have other plans—like health for example. Business owners often don’t understand the high risk associated with this concentrated focus, or the amount of exposure to unforeseen events it entails. Having a blueprint helps protect you, as the owner, from different contingencies that could happen. Planning early allows time to grow and diversify your investment for the future – so you can enjoy not only the business aspect of your life but also your personal life.
Not many people understand the variety of available retirement plans, including traditional pension plans, and how they can benefit you as a small business owner. Having the right retirement plan for your company may provide long-term rewards for your business, you, and your employees. Here are some examples of the different types of plans that you can offer:
A 401(k) defined-contribution plan is a tax-deferred plan that is sponsored by the employer, and allows the pre-tax money contributed to an employee’s account to grow over time. If an employer decides to open a 401(k) plan for their business, they have the ability to support their employees’ plans by contributing to all workers, matching employees’ deferrals, or even doing both.
As its name suggests, a 401(k) defined-contribution plan lets the employer define the specific amount of money, if any, they want to contribute towards their employees’ retirement.
For 401(k)s the IRS has set certain limits for employees to defer money, such as:
Note: at age 70 and a half, there are required minimum distributions to calculate*Contribution limits displayed ae as of 2018. These amounts are subject to change year by year. Please consult a tax, human resources, or retirement professional to understand and obtain the most current information.
The defined-benefit pension plan is an employer-sponsored retirement plan that provides your participants a guaranteed benefit when they retire. The benefit is subject to a vesting schedule. Usually, this is calculated through a formula using factors such as the census of the company, which contains the age, years worked and the wage/salary of the employee. This type of retirement vehicle is known to have the ability to contribute higher levels of pre-tax contributions.
A profit-sharing plan is another type of retirement plan that offers the employer an opportunity to make a big contribution to their own retirement savings, as well as the savings of their employees. The profit-sharing plan and 401(k) are somewhat similar; the big difference between the two plans is that the employer is the only party that can contribute to the profit-sharing retirement plan.
A huge advantage this retirement plan offers is that the employer’s annual contribution is entirely discretionary. This means there is no set amount the employer is required to contribute. The employer is responsible for establishing, managing and funding the retirement plan on their employees’ behalf, and as of 2018 the employer contribution limit is 25% of eligible payroll.
The Employee Stock Ownership Plan (ESOP) includes shares of a company’s stock as part of its employees’ remuneration. Shares are typically held in an ESOP trust for the duration of the worker’s employment, then exchanged for cash. An ESOP is commonly used by closely held firms because it allows owners to sell their shares to the plan at their discretion, making a more orderly leadership transition possible.
At EP Wealth we are very familiar with the type of small-business owners considered to be solopreneurs. Whether you’re a PGA tour golfer or a consultant or any type of independent contractor whose payments are reported on IRS form 1099, we can help you establish an appropriate plan for retirement.
The typical solopreneur is looking for a retirement vehicle that provides the investment flexibility common to the other plans we’ve discussed, while being as simple as possible to establish and maintain. Several options are available.
The Solo 401(k) performs the same function as a regular 401(k), but this plan only requires you as a participant. These plans may be more attractive than SEP plans discussed below, primarily because they allow you to contribute both as an employer and an employee, which may allow for a higher total annual contribution.
The SEP IRA is a type of traditional IRA and is used mostly by small-business owners or self-employed individuals. Like most IRAs, the money being invested in the SEP IRA will not be taxed until withdrawal.
The SEP IRA contribution limit is 25% of net income or a maximum of $55,000.
The Simple IRA is a type of retirement plan often used by small-business owners who have 100 or fewer employees. Oftentimes, many employers choose this plan because it tends to be cheaper and less complicated. Simple IRAs have a built-in “employer-matching incentive” where the employer is required to match the employee’s contribution or contribute towards the employee’s plan. Usually this contribution equals around 1 to 3 percent of an employee’s salary but varies amongst the different employers.
The contribution limits for a Simple IRA are:
To briefly recap, small businesses of all sizes and ages have compelling reasons to consider creating retirement plans:
My colleagues and I at EP Wealth can help you navigate the process of creating or refining a retirement plan that fits you and your business. If you’re ready to take the next step, please feel free to contact me today!
You may also want to check out our Business Planning page to explore how EP Wealth Advisors can help direct you on the right path to retirement.
EP Wealth Advisors (“EPWA”) makes no representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented in this report. EPWA has used its best efforts to verify the data included in this report. The information presented was obtained from sources deemed to be reliable. However, EPWA cannot guarantee the accuracy or completeness of the information offered. All expressions of opinion are solely of the authors and subject to change without notice.
Information presented is general in nature and should not be viewed as a comprehensive analysis of the topics discussed. It is intended to serve as a tool containing general information that should assist you in the development of subsequent discussions. Content does not involve the rendering of personalized investment advice nor is it intended to supplement professional individualized advice.
The Retirement Benefit options available to corporations, partnerships, sole proprietors, contractors and other types of businesses encompass a number of additional options and retirement plans that were not referenced or considered herein. The decision to incorporate a retirement plan and the type of retirement plan are subject to the unique needs of every business. For this reason, options not described may be better suited to the needs of your business. Always consult with Human Resources, tax and legal professional prior to implementing anything referenced or implied here.
Hiring a qualified advisor, financial planner and/or establishing a retirement plan do not guarantee investment success, and does not ensure that a client or prospective client will experience a higher level of performance or results. No guaranty or warranty is made that any results, projections, or other information being represented or implied will be met or sustained.
EP Wealth Advisors is not in the business of providing legal or tax advice or preparing legal or tax documents. Please consult with a CPA, tax professional, and/or attorney regarding your specific situation before implementing any of the strategies referenced directly or indirectly herein.
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