Small/Micro Business Retirement Plan Overview: My Chat with Jill James
Recently I did a LinkedIn Live with Jill James of Sif Industries - we discussed small business finance and retirement plans. Here's an overview of our chat in Q&A format, plus some of the things that I wish I had thought to share with you!
What retirement plans should I be considering?
For small business owners, if you want to save $6,000 or less, you can use a Traditional or Roth IRA. Once you exceed that amount, the most common options are a SEP, SIMPLE, or 401k. Retirement plans are federal, so it doesn't matter where your business is located in the US. We all have the same options.
You will want to note, however, that there are a few states that offer a state-sponsored IRA retirement plan. That is also available to you if you live in one of those states, such as Oregon, California, Illinois, and others.
How much can I save?
SIMPLE IRAs allow you to contribute up to $13,500 ($16,500 if you're turning age 50 or older this year). In a SEP or 401k in 2020, it may be as much as $57,000 ($63,500 for age 50+). Your maximum contribution will depend on your plan type, company profit, and salary. For example, SEP contributions are strictly contributions the employer makes on behalf of the employee whereas 401k plans can have multiple sources including employee deferrals, employer profit sharing, employer match, etc. Also check the IRS website for contribution limits, which change as often as annually, since they're indexed to inflation.
What should I consider when choosing and designing a plan?
You should consider how profitable you are, how much you want to save, whether you have (or plan to have) employees, what Safe Harbor or other employer contribution requirements you'll need to meet, what appetite you have for fiduciary administration and overhead, and what kind of investment options and responsibility you want to have within the plan. When you run scenarios for the plan type, make sure to review it with your accountant to make sure you understand the “true” cost and also the tax savings!
SEP and SIMPLE are both IRA plans, so if you have employees, they are responsible for setting up their own account and selecting investments. In a 401k, you, as the plan sponsor, will have oversight on that investment menu selection and must make sure the plan is run in alignment with the rules in its plan document as well as federal regulations. (Welcome to fiduciary responsibility, and welcome to a new overhead cost. Budget $5000.) SEP and SIMPLE both have 100% immediate vesting on any amounts that you might give to employees. 401k can use a vesting schedule, where employees earn ownership [read: portability if they leave working for you] of the employer contributions over time.
Generally speaking, the more generous you are with employees, the more generous the IRS lets you be with yourself and the higher paid management group as far as contributions go in a 401k plan. While IRAs are not subject to non-discrimination testing, 401ks are (part of the added administration expense). The skinny is that the owners/highly compensated employees can't be benefiting from the plan substantially more than the rank and file or the IRS makes you jump through certain - sometimes expensive - hoops. If you can afford to give everyone a 3% contribution or a 4% match, you can forgo the testing with a Safe Harbor contribution plan design.
What deadlines do I need to meet?
If you don't have an existing plan, you have two options for 2020: set up and fund either a SEP or a 401k in Q1. (In this scenario, with either plan you'll be contributing employer dollars, no salary deferrals for 2020.) You have until you file your 2020 taxes plus extensions, either March 15 or April 15, 2021, to get either plan open and funded. (the 401k deadline is new with the SECURE Act.) Check with your accountant for details. If you have an existing 401k, you will be able to make a profit sharing contribution through the time you file your taxes plus extensions. If you prefer to start a 401k in 2021, set that up as soon as possible so you can start making deferred salary contributions.
What other things do I need to know about starting a plan?
In addition to the nice tax savings that you have, you may be able to claim a tax credit up to 50% of the costs for some of the ordinary and necessary costs of starting a SEP, SIMPLE IRA or 401k. Reminder: a tax credit reduces the amount of taxes you may owe on a dollar-for-dollar basis. You can get more details here: https://www.irs.gov/retirement-plans/retirement-plans-startup-costs-tax-credit
Who should I call to get one of these plans?
For yourself or just a few employees, a financial advisor, your state-run plan’s website, private wealth manager at your bank, or even an online brokerage are your best options. If you have a larger number of employees - say, over 10 - and you're starting to think not just in terms of your own tax and retirement savings but also company growth, retention, and recruiting, you'll want to work with a retirement plan advisor/specialist (you know, like us!). It's a good idea to revisit your plan annually just to make sure it's still living out it's intended purpose. It is easy for the retirement plan to fall out of alignment with its original purpose as your business grows and changes.
Start by answering this question: What's this retirement plan supposed to do for me and my business? It’s also a good idea to make your financial team talk to each other to align goals -- accountant, financial advisor, retirement plan advisor, etc.
Further Help - IRS links
Believe it or not, the IRS website is a treasure trove of information that is accessible and straightforward. Start here to get the nuts and bolts of each plan type:
IRS – Simplified Employee Pension Plan
You can also view my chat with Jill here.
Final note:
Everything in this article is there to help you get started and know the questions to ask, and is intended as educational in nature only. You need to consult the appropriate tax professional for help on your particular situation. Retirement Planology doesn’t render legal or tax advice!