This is the beginning of a series of 5-minute guides for busy entrepreneurs that help give a high-level view of important financial planning concepts for their family’s finances.

Successful entrepreneurs are truly the busiest people I know. Whether it is a small business owner or a founder/CEO with 1,000 employees, time is the most valuable resource they have.

Entrepreneurs juggle family, business, social commitments, charity work, and a host of other things on any given day.

How they use and steward their time can mean the difference between bankruptcy and strong profitability.

Our goal is to help entrepreneurs reclaim and repurpose time by providing these types of resources along with our expertise. 

In this guide, we will review 5 retirement plans for small business owners.

Traditional IRA

A traditional IRA allows an individual to contribute $6,000 ($7,000 if you are 50+ years old) in 2022. These contributions are generally tax deductible and grow tax-deferred. Withdrawals from Traditional IRA before age 50½ may be penalized 10% (the IRS does allow some exceptions). There are income limits to some of these benefits. 

These are best suited for:

• Entrepreneurs who expect to be in a lower tax bracket in retirement.
• Entrepreneurs who do not have a lot of income yet. 
• Entrepreneurs who have not left their day job and have access to other retirement options, like a 401(k).
• Entrepreneurs who can’t contribute to a Roth IRA due to their income being too high.

Downsides for the Entrepreneur:

• Generally, Traditional IRAs are penalized 10% if the funds are withdrawn early except for certain uses, such as unreimbursed medical expenses. Using the funds to invest in your company or provide you with personal liquidity would most likely be penalized.
• Traditional IRAs require you to take a minimum distribution annually after a certain age (around 72). These distributions are taxable income and depending upon your situation, these could bump you into a higher tax bracket in retirement. 

Roth IRA 

A Roth IRA allows an individual to contribute $6,000 ($7,000 if you are 50+ years old) in 2022. These contributions are generally not tax deductible but do grow tax-free. There is a 10% early withdrawal penalization and earnings will be taxed (the IRS does allow some exceptions). There are income limits to contributing to a Roth.

These are best suited for:

• Entrepreneurs who expect to be in a higher tax bracket in retirement.
• Entrepreneurs who do not have a lot of income yet. 
• Entrepreneurs who have not left their day job and have access to other retirement options, like a 401(k).
• Entrepreneurs who may need the funds later. Early withdrawals can potentially have fewer penalties, making it easier to use for your business or personal liquidity.

Downsides for the Entrepreneur:

• Roth IRAs have income limits, so if an entrepreneur has a modified adjusted gross income between $144,001 and 214,001 (depending upon filing status) they will need to use a Backdoor Roth.
• Roth IRA contributions are not tax deductible and will not help lower your taxable income.

SEP IRA

A Simplified Employee Pension (SEP) IRA is very similar to a Traditional IRA. SEP IRAs are for business owners and allow an entrepreneur to contribute $61,000 (or 25% of your compensation) whichever is smaller. 

These contributions are tax-deductible and grow tax-deferred. 

There is a 10% early withdrawal penalization and distributions in retirement are considered taxable income.

These are best suited for:

• Entrepreneurs with few or no employees. If you have employees, there are a lot of requirements and rules you will need to follow.
• Entrepreneurs who have significant income and are looking to lower their taxable income.
• Entrepreneurs who have not left their day job and have access to other retirement options, like a 401(k).

Downsides for the Entrepreneur:

• In addition to the downsides mentioned above in the Traditional IRA, if you have employees, you are required to contribute the same percentage to their funds. So if you are contributing 20% of your compensation, you will need to contribute 20% of their compensation as well.

Solo 401(k)

The Solo 401(k) is designed for entrepreneurs with no employees. An individual can contribute up to $61,000 in 2022, with an additional $6,500 catch-up contribution if 50 or older. You can create a Roth or a Traditional version of this retirement plan.

For a Traditional 401(k), contributions are made pre-tax, reducing your taxable income. Contributions to a Roth 401(k) are made with after-tax dollars.

Distributions from a Traditional 401(k) are taxed as income, while distributions from a Roth 401(k) are tax-free.

If your spouse earns income for your business, you can effectively double the amount you can contribute as a family. If a couple over the age of 50, owned their own business, they could contribute $135,000 ($61,000 + $6,500 = $67,500 each). 

These are best suited for:

• Entrepreneurs with no employees other than a spouse.
• Entrepreneurs who have significant income and are looking to lower their taxable income. 

Downsides for the Entrepreneur:

• You can not have any employees other than your spouse. 
• These plans have a greater administrative burden than the other options above.
• Depending upon if you open a Roth or Traditional 401(k), early withdrawals generally mean paying taxes and penalties.

Defined Benefit Plan

The Defined Benefit Plan provides a fixed, pre-established benefit for employees at retirement. For entrepreneurs with no or few employees, this can be a way to save 25 years of retirement in 10 years.

Contributions are based on actuarial assumptions on age, investment return, and some other variables but the IRS allows up to $245,000 for 2022. 

Contributions are generally tax-deferred, enabling a huge opportunity for tax savings. 

These are best suited for:

• Entrepreneurs with few or no employees.
• Entrepreneurs who have significant income and want to lower their tax burden.
• Successful entrepreneurs who want to max out their retirement contributions.

Downsides for the Entrepreneur:

• Higher administrative cost.
• With some exceptions, contributions must be made annually, no matter if the business did well or not.

Clear Creek Conclusion

Choosing the right retirement plan is largely dependent upon your current circumstances. 

Entrepreneurs might need to create 2 or 3 different plans throughout their careers. 

For example, a small business owner may only need a Roth IRA because they can only contribute $2,000 a year to their retirement savings. A few years later, they might need to open a SEP IRA to contribute $30,000. Eventually creating a Defined Benefits Plan to save $160,000 a year.

Choosing the right retirement plan is an important step in reaching your retirement goals. 

If you want to save time and need any help deciding on what plan is best for you, reach out. We would be happy to help you establish an account and help you manage your finances.