One of the areas that concerns me about small business owners is retirement accounts. Many small business owners do not have a retirement account. A common reason for this that I hear is, “When my company starts making enough profit, I will open an account.” My response usually is, “How do you define enough?” As long as your business brings in money (not, if you have a net profit), you should be paying into your future. For every new client I onboard, the question “Do you have a retirement fund?” comes up.

There are different retirement avenues available for small business owners. This blog looks at a bird’s eye view of three retirement accounts available for small businesses. The information for each is not exhaustive, but it is enough to help you start thinking and asking your financial advisor or CPA the right questions. Let’s get started.

Solo 401K
Solo 401Ks benefit solely business owners  (and their employed spouse) who have not elected to be taxed as corporations (that is, pass-through entities), for example, sole proprietorships and partnerships. The employee’s deferral contribution amount and the employer’s contribution are based on the business’s net adjusted income, which is calculated by taking the gross self-employment income minus business expenses minus half of self-employment taxes. What does this mean for the employee versus the employer?

Employee contribution: 100% of the net adjusted income up to the current year ($23,000 for 2024) maximum. There is an additional catch-up ($7.500 for 2024) for those 50 or older.

Employer contribution:  Up to 20% of the net adjusted income. The annual net adjusted income limit fluctuates yearly ($345,000 for 2024).

There are two types of solo 401K accounts, a traditional 401K and a Roth 401K. What is the difference?

The traditional 401K allows for the deduction of contributions as expenses in the year the contributions are made. However, future distributions (at retirement) will be taxed as ordinary income.
The Roth 401K is the opposite of the traditional 401K. Therefore, contributions are not allowable business deductions. However, future distributions (at retirement) will be tax-free.

Note: For partnerships, the computation of modified net profits is required. Refer to IRS Publication 560.

SEP (Simplified Employee Pension) IRA
This retirement option allows small business owners to contribute to their and their employees’ retirement accounts. Every eligible employee is 100% vested in the SEP account. The SEP IRA is similar to the traditional 401K; contributions are tax-deductible in the year they are made. However, future distributions (at retirement) will be taxed as ordinary income.

The contribution limits for the SEP IRA are set at the lesser of:

  • 25% of the employee’s compensation (on a total income of $345,000 or less – for 2024) or
  • $69,000 (for 2024)

The SEP does not offer catch-up contributions for any employees.
The rules for which employees can participate include:

  • Has reached age 21
  • Has worked for the employer in at least 3 of the last five years
  • Received at least $750 in compensation in 2023 or 2024
  • An employer can use less restrictive participation requirements than those listed but not more restrictive ones.

SIMPLE (Savings Incentive Match Plan) IRA
The SIMPLE IRA is a retirement plan where an employer can contribute to employees’ retirement accounts, and employees may also contribute to their accounts. Contribution limits for 2024 are $16,000. There is a $3,500 catch-up for eligible employees who are 50 years or older. The main rule for eligibility is that the business employed no more than 100 employees in the preceding calendar year who had $5,000 or more in compensation. Besides the differences mentioned above, the SIMPLE IRA is similar to the SEP IRA in many ways. 

We have looked at only three ways a small business owner can invest in her (and perhaps her employees’) future. Contact your financial advisor or CPA for more information on these or other retirement plans that fit you well. Remember, as you grow your business, make sure to grow your personal future by opening a retirement account this month.

DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.