The US of A: a country born on the small business, the Ma and Pa custard stand, and the corner drug store. It’s the foundation of the entrepreneurial drive that defines the garage startups across the world. Maybe you’re familiar with the phrase "small business is the backbone of the US economy."
According to the US Small Business Administration (it’s .gov so you know it’s for real) small businesses have a big impact:
- The 28 million small businesses in the US account for 54% of all US sales
- Small businesses provide 5% of all jobs and 66% of all net new jobs since the 1970s
- The 600,000 plus franchised small businesses in the US account for 40% of all retail sales and provide jobs for some 8 million people
- The number of small businesses in the US has increased 49% since 1982
- Since 1990, as big business eliminated 4 million jobs, small businesses added 8 million jobs
[Now the things that I am about to mention fall more under the employee benefits/owner benefits side of the spectrum. As a financial advisor, this is where my specialties lie. I am in no way a student of the IRS code and I too work regularly with a tax accountant, as you as a small business owner, should as well.]
So, small businesses are kind of a big deal. Due to the staggering amount of small businesses in the US and the effect that they have on the economy, the government offers some perks that, if you’re a small business owner, you should be aware of.
First, we’re going to start with the types of retirement plans that small businesses might consider. There are basically four different types of retirement plans that a small business owner can take advantage of:
- Simplified Employee Pension Plan (SEP IRA)
- Savings Incentive Match Plan for Employees (SIMPLE IRA)
- Self-Employed 401(k) Plan
- General 401(k) plan (what people are most familiar with
Out of these four, we are really only going to focus on the SEP IRA, SIMPLE IRA, and the Self-employed 401(k) Plan. The reason being that a more traditional 401(k) style plan for a business of 10 or less might not be a good fit due to higher setup and/or administrative costs.
Back, Back it Up
Let’s back up for a second, why have a plan anyways? If you’re an owner and it’s me, myself, and I, can’t I just deposit into a regular IRA like anyone else? Absolutely you can, buuuuuut you are missing out on some opportunity. Let me explain further. First, if you have employees, it’s a great way to help them be proactive about saving their dollars for the future. Most small business owners have a really close connection to their few employees and want to do all they can to provide the right tools for the future financial success of their employee. Secondly, it probably helps with employee retention, don’t you think? Lastly, every small business owner's favorite word: deductions.
The following chart is from Fidelity. I think it does a great job at breaking down the important factors regarding the differences among SEPs, SIMPLEs and SE 401(k)s.
I lost you at the chart, didn't I? Hopefully, most business owners were able to pick up on the flow of things. Now, it’s time to make a decision about which plan best fits your company. It’s always best to think about the things that you want your plan to accomplish and then work backwards to figure out which of the options is right for your business.
Which is best?
It really depends on what you’re looking to accomplish. If it's just you, maybe a spouse, and no other employees, the Self-Employed 401(k) could be the way to go. This plan lets you store away quite a bit of money compared to some of the other plans out there. Because in this plan you are considered both employee and employer, you are able to make elective deferrals of up to $18,000 as the employee, and, with the up to 25% compensation on profit-sharing, an additional $36,000 for a maximum of $54,000 for the year. Woah.
[Elective deferrals are amounts contributed to a plan by the employer at the employee’s election and which, except to the extent they are designated Roth contributions, are excludable from the employee’s gross income.]
If you’re a business that has a few employees and have some variable income, maybe you’d want to consider a SEP IRA. The SEP allows for similar contributions of 25% of compensation up to the $54,000 max, but remember, as an employer, you must contribute the same % to an employee account in the years you contribute to your own account. The flexibility lies in the fact that you are not required to make that contribution at all.
If you have more than a few employees but less than that 100 mark, it might be a good idea to pursue a SIMPLE IRA for your business. The SIMPLE doesn’t quite allow you to pack away nearly the same as the other accounts, but it does allow you to give some of the heavy lifting to the employees. Employees can make a salary deferral of up to 100% of compensation (which seems very generous, but it’s limited to the $12,500 mark here in 2017). As an owner you are required to make contributions to employees plans on an annual basis following the rules noted above.
Deciding what you want the plan to accomplish is the biggest key for a small business owner. Most first time business owners may just be familiar with regular 401(k)s and think that’s what they must establish when becoming a business owner. Unfortunately, they have agents trying to get them into these plans due to their steeper prices even though it may not be the best fit for the business. It’s important to educate yourself on the options and reach out to professionals that have the incentive to keep your business's best interest in mind.
Side note: did you know that professions such as relators and other commission-based professions have the ability to take advantage of some of these plans?
financial advisor, economics junkie, sports fanatic
"Money is tough, it's something that we all use on a daily basis, yet it doesn’t ever come with instructions. If you have questions, reach out to me or someone else at Fischer Wealth Management so we can help you achieve what matters."