RETIREMENT PLANS FOR THE SMALL-BUSINESS OWNER
AND THE SELF-EMPLOYED
Many self-employed small-business owners with either a few employees and perhaps a
partner, or no employees other than themselves, don’t have a company retirement plan. They
complain that the choices are too confusing, the plans too costly to set up and maintain, and too
expensive to include employees.
But small-business owners (SBOs) have better options than they may realize, say financial
planners, and the reality is that SBOs cannot afford not to set up a retirement plan. While many
assume they’ll simply sell their business when it’s time to retire and live off the proceeds, it’s
risky to project whether what they receive for the business will be sufficient. A well-funded
retirement plan adds security.
Exactly which plan to choose depends on many factors, including whether you have
employees and whether you want to help them with retirement, how long you have before your
own retirement, what you currently have saved for retirement, and how much money you’ll need
to pay for the retirement you envision.
Here are several retirement plan choices for small-business owners.
Solo 401(k). Tax law changes in 2001 made this a major new option for business owners
with no employees other than a spouse or a partner.
Under a solo 401(k), you can annually contribute up to $41,000 to the plan as a combination
of employee deferral and employer contributions. In addition, you can kick in another $3,000 in a
“catch-up” contribution in 2004 if you are age 50 or older.
Simplified employee pension (SEP). SEPs, which are set up as individual retirement
accounts for each employee but which allow contributions far larger than standard IRAs, are easy
and inexpensive to establish and maintain. The owner can put in up to 25 percent of
compensation or up to $41,000 in 2004 (based on a maximum compensation of $205,000),
whichever is less. (Special calculation rules apply to self-employed individuals.)
The major drawback of SEPs for some owners is that they must fund contributions for
eligible employees at the same rate they fund their own accounts. Moreover, employer
contributions are immediately vested. Generally, owners must include employees if they are at
least age 21, have worked three out of the preceding five years for the owner, and have earned at
least $450 for the year (employers can make eligibility less strict).
Savings incentive match plan for employees. Owners whose personal income from their
business is modest but who still want to maximize retirement contributions—perhaps it’s a side
business—may want to consider a SIMPLE plan. That’s because they can defer as much as 100
percent of their compensation up to $9,000 in 2004 ($10,000 in 2005), plus another $1,500 if age
50 or older. For example, if you make $30,000, you can put $9,000 into a SIMPLE but only
$7,500 into a SEP.
Unlike a SEP, employees are responsible for funding their SIMPLE accounts (again, set up
as an IRA), but the owner must match employee contributions. Generally, the owner must match
a dollar for each dollar contributed by an employee, up to three percent of the employee’s pay.
The employer can go as low as one percent, but for no more than two out of every five years. A
third choice is to make a two percent non-elective contribution (up to $4,100), meaning the
contribution must be made even if the participating employee doesn’t contribute.
Eligible SIMPLE employees are those who earned at least $5,000 in any two preceding years
and who are expected to earn at least that much in the current year, unless you choose to have
lower requirements. You can exclude employees covered by a union agreement.
Other plans. Business owners have additional options, such as profit-sharing and Keogh
plans. Another consideration is defined-benefit plans, which would allow an SBO who’s late to
the game saving for retirement to quickly stash away large amounts of money. DB plans can be
expensive to set up for small businesses and you’re actuarially committed to setting aside a
certain amount regardless of profits. But less expensive versions, even for the self-employed, are
As is clear from the many options, you’ll want to run the numbers with your financial
planner to see which plan best fits your needs.
June 2004 — This column is produced by the Financial Planning Association of Southeern Wisconsin. We
can be a continued resource for your personal finance coverage. If you use this column in whole or part,
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