The Best 401(k) Plans For Entrepreneurs

So, you’ve taken the big leap and started your own business! Time to get started on that checklist. Website is up and running, orders are coming in, business plan all written out. But something is still missing…a retirement account? Now? Your early 20s or 30s may seem too early to think about retirement. After all, you just started! But starting early is crucial. You worked hard, you want something to show for it later, right?

What exactly IS a 401(k)?

A 401(k) is a retirement savings and investing plan with tax benefits that employers offer employees. Essentially, a small part of your paycheck is withdrawn and invested in your retirement fund. Now, not every employer offers a 401(k). In that case, you can open an IRA (Individual Retirement Account). Any person with earned income can open an IRA savings account through a bank, investment company, or personal banker. 

Different Kinds of 401(k) Plans

There are two main kinds of 401(k) plans: Traditional and Roth 401(k). 

In a traditional 401(k) plan, contributions are taken out of your paycheck before taxes. This comes with its own benefits—for instance, this lowers your taxable income for the year. Once you put money into your 401(k), you pay no taxes on investment growth, interest, or dividends until you start making withdrawals in retirement. 

In a Roth 401(k) plan, contributions are taken out of your paycheck after taxes. Because you made your contributions after taxes, you owe the IRS nothing when you start making withdrawals in retirement.

The Best 401(k) Plans for Entrepreneurs

So, now that we’ve covered what a 401(k) plan is and where they come from, it’s time to answer the big question: If 401(k) plans are provided by your employer, how do you pick a 401(k) plan when you’re self-employed?

Here are some of the most common types of 401(k) plans for entrepreneurs and small business owners:

Individual 401(k)

An individual 401(k) has many of the same benefits as a traditional 401(k). As a small business owner, you can make contributions to your 401(k) plan for both employee and employer. 

In a 401(k) plan, employees’ contributions are called elective deferrals and employers’ contributions are called non-elective deferrals. Employees can contribute 100% of their compensation to their 401(k) (up to the $19,500 limit). Employers can contribute up to 25% of their compensation after taxes. 

Once this plan is set up, business owners continue to make contributions as employer and employee until they retire. One of the biggest benefits of an Individual 401(k) is that it includes your spouse. If you co-own a company with your spouse, you both can contribute to your retirement plan as both employee and employer.

SIMPLE IRA

SIMPLE stands for Savings Incentive Match Plan for Employees Individual Retirement Account. This plan is perfect if you’re looking to expand your business. It works similarly to an IRA, in that employees can choose to make salary reduction contributions, and the employer matches it. This plan works best for small businesses with 100 employees or less, and employees must earn at least $5,000 per year. 

In a SIMPLE IRA, the employer establishes an IRA for each employee. Then both the employer and employee contribute to these accounts and earn tax benefits. 

What are the benefits of a SIMPLE IRA? Well for one, costs to establish and maintain a SIMPLE IRA are lower, and the set-up process is simple. Contribution limits in a SIMPLE IRA are more generous, too. In 2020 and 2021, employees can contribute up to $13,500. 

SEP IRA

An SEP IRA is a Simplified Employee Pension. In a SEP, business owners can make pre-tax retirement contributions for both themselves and employees. Compared to a traditional 401(k) plan, a SEP is simple to start and manage. There’s less paperwork and no annual filing. Another advantage is that the contribution level for a SEP is more than double that of a traditional 401(k). Employees can contribute as much as 25% of their annual compensation, and employers can contribute as much as 25% of their earnings. The maximum amount for both employees and employers is $58,000 in 2021 (compared to $19,500 in a traditional 401(k)). 

Business owners can also deduct SEP contributions as a business expense. 

It’s also important to keep in mind that as a business owner, you must contribute the same amount for every employee. So if you want to contribute 15% of your income to a SEP, you must contribute 15% for each of your employees’ salaries to a SEP. 

This can all sound a bit tricky, especially if you’re a first-time business-owner. It’s important to keep in mind that  you can always consult an accountant or financial advisor if you have any questions or concerns.

Do you have any suggestions for picking a 401(k) plan? Let us know down in the comments!

This article originally published on GREY Journal.