By Katie Tejada
Individual retirement accounts, or IRAs, are essential to consider as business owners plan for and create their financial retirement goals. They can offer you tax advantages and investment opportunities that extend far beyond a typical savings account.
If you are like many small business owners, you may be a little overwhelmed by the choices available to you. There are four types of IRA accounts that are well-suited for business owners, including traditional, SIMPLE, Roth, and SEP.
Each one has an individual strategy, set of requirements, contribution limit, and withdrawal rules. Understanding account types will give you the chance to select one that is right for you, your business, and goals. Though you should speak to your business CPA for further advice on finding a plan for unique situation, here are four retirement accounts you should explore.
1. Traditional IRA
A traditional IRA provides you with a chance to grow your savings under a tax-deferred program. This means that you won’t have to pay taxes on profits generated at the federal, state, or municipal level until you withdraw from the account. Plus, a traditional IRA can offer tax deductibility, depending on your earning levels and life stage.
The traditional IRA is an ideal plan for small business owners without employees who earn less than $100,000 annually. It’s a flexible program that is supplemental in nature so it can easily combine with a 401(k).
Plan Requirements: There are income and eligibility requirements. Contributions cannot occur after age 70½.
Contribution Limits: As of 2019, the maximum contribution limit is $5,500. Individuals 50 years and up can add an additional $1,000 annually, for a total of $6,500. It’s a strategy known as a “catch-up” contribution.
Withdrawals: Withdrawals may begin at 59½ years old without incurring the 10% early withdrawal penalty. All withdrawals are subject to taxes.
2. SIMPLE IRA
A savings incentive match plan for employees’ IRA, or SIMPLE IRA, is a more robust option that isn’t as complex or expensive as other programs. It works like a traditional IRA but imposes contribution requirements if you have employees. Contribution limits are higher for SIMPLE IRAs versus tradition IRAs.
Plan Requirements: You must have fewer than 100 employees.
Contribution Limits: You are required to make contributions if you have employees in one of two ways:
- You can match contributions up to 3% of the employee’s salary; or
- You can pay a flat 2% rate contribution, whether the employee contributes or not.
Whether you have employees or not, the maximum contribution limits are the same. A SIMPLE IRA has a $13,000 cap for individuals under 50 years of age. The “catch-up” amounts are limited to $3,000 if you are older than 50.
Withdrawals: Like a traditional IRA, a 10% penalty is imposed by the IRS on SIMPLE IRA withdrawals that occur before age 59½. Withdrawals made within two years of opening the account results in a 25% penalty rate.
3. Roth IRA
A Roth IRA is funded like most IRAs, but they are taxed differently. First, a Roth IRA contribution is not tax-deductible at the time deposited. However, all profits generated are tax-free since deductions weren’t made upon funding. It’s a good option when retirement planning for business owners when you anticipate paying a higher tax rate during retirement.
Plan Requirements: The IRS has placed income limits on eligibility requirements for Roth IRAs. Eligibility is based on your modified adjusted gross income, or MAGI.
Contribution Limits: Contributions towards Roth IRAs are limited to $6,000 per individual. Married couples can contribute $6,000 each, even if only one person is self-employed or otherwise. The “catch-up” limits are $1,000 if you are 50 years or older.
Withdrawals: There are no tax payments on early withdrawals if you draw before the age of 59½. There is a 10% penalty for non-qualifying early withdrawal exceptions.
4. SEP IRA
For high-earning self-employed individuals without employees, a simplified employee pension IRA, or SEP IRA, is an attractive option. While you can offer this type of IRA to employees, contributions to yourself require that you contribute to your employees as well. Contribution limits are also much higher and tax-deductible. An SEP IRA does not require annual contributions if there are years where you do not wish to make contributions to engage in retirement planning for business owners.
Plan Requirements: All contributions you make must be matched with employees by percentage. For example, if you contribute 15% of your income toward the SEP IRA, your employees must be matched at the same 15% rate. If you have employees, they must meet the following requirements:
- Earn more than $600;
- Be older than 21 years of age;
- Worked with you for three of the past five years.
Contribution Limits: Contributions max out at 25% of your net income with a maximum of $56,000 for 2019.
Withdrawals: Like other IRAs, the SEP IRA asses a 10% penalty and income tax on withdrawals made by individuals younger than 59½.
Help with Retirement Planning for Business Owners
There are many opportunities to save and invest in retirement when you are business owner. Each plan has different advantages and disadvantages, depending upon your age, marital status, income, and the number of people you employ. Consider working with a CPA or financial advisor to help you make critical decisions regarding retirement planning for business owners.