I am starting my own business and I want to set up a retirement plan. What should I do?
As a firm that specializes in helping small business owners, we know how overwhelming it can be when you’re starting a business, and trying to take care of all of the related details. Presumably you are embarking on your new venture because you have a great idea you expect to profit from. To make the most of your efforts, it’s best to establish a retirement plan early on, so you can save and invest a portion of your proceeds in tax-favored accounts.
These days, there is a wide and growing range of retirement plan solutions for the small business owner – as well as a wide and growing range of related requirements. Because selecting and implementing the best plan for you and your business depends on a number of specifics, we suggest speaking with a professional advisor to help you weigh the options and manage the operations. Following is an overview to get you started.
The Solo- or Owner-401(k) Plan
If you don’t have employees, a solo- or owner-401(k) may be the best way for you and your spouse to save money from your business profits, with two contribution opportunities from your dual role as employee and employer:
• Your employee contribution allows you to save $18,000/year if you are under 50, and $24,000/year if you are 50 or older.
• Your employer contribution allows you to save an additional 25% of your salary.
For example, if you pay yourself $100,000/year and you are 50 or older, you can contribute $24,000/year as an employee and $25,000/year as an employer (in addition to your salary), for a total of $49,000 annually. The maximum 401(k) contribution is $53,000 if you are less than 50 and $59,000 if you are 50 or older.
The SEP IRA
What if you and/or your spouse is employed at another company and maximizing the employee contribution there, but one or both of you are also running a small business of your own? You can set up a “self-employed” or SEP IRA for your separate business. The contribution limit for a SEP cannot exceed the lesser of 25% of your self-employed compensation or $53,000 per year. These are the guidelines for 2015 and 2016, and are subject to annual cost-of-living adjustments for future years.
Defined Benefit or Cash Balance Plan
If you want to save even more than described above, you can consider a defined benefit plan or a cash balance plan. The limits for these plans are around $200,000/year but it depends upon age and income. Typically, you set an annual contribution amount and there is a range around it. Y ou are required to contribute each year.
Defined benefit and cash balance plans are more complex to set up and administer, but if your situation calls for it (for example, you are older with high income), they can be a great way to save even more than you can in a 401(k) plan. They also can be paired with a 401(k) plan, but this limits the employer contribution part of the 401(k) plan.
Company 401(k) Plan
Once you have employees, you can consider a company 401(k) plan to help you save for your own retirement while providing an important benefit to your valued employees.
A company 401(k) plan is more complex, and the current regulatory environment may soon call for even higher levels of vigilance with respect to your fiduciary duties as the plan sponsor. If you are considering establishing one, we suggest aligning with a Registered Investment Advisor relationship that includes accepting the fiduciary role of acting as your plan’s 3(38) investment manager. This doesn’t relieve you of all fiduciary duty to your plan participants, but it helps you sensibly shift the investment management portion to a professional investment manager.
Regardless of which plan or combination of plans makes the most sense for you, there are a number of custodians who are set up to house the assets for you. For the relatively straightforward solo-401(k) or SEP IRA, there should be no additional set-up fees. If you are planning to establish a company 401(k), defined benefit or cash balance plan, expect additional administrative and management fees to apply.
Circling back to where we began, if you are considering launching or have recently launched a new business, we are ready to help with your retirement plan set-up. Please feel free to reach out to us if you have any questions.
Robert J. Pyle, CFP®, CFA is president of Divers ified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail firstname.lastname@example.org.
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