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Why You Should Consider a Small Business Owner 401(k)

Why You Should Consider a Small Business Owner 401(k)

Although you likely started your small business because you love the work you do and are able to be your own boss, if you’re like most of the small business owners that I talk to, you’re also looking forward to retirement. You may even know the exact number of years, months, days, and hours until you’re finally ready to turn in your keys and sit back and enjoy life a bit.

That is certainly understandable after years and years of hard work and effort. However, the one question I have for you now is how you intend to fund your retirement.

If you worked someplace else prior to making the leap into self-employment, then it is possible that you will have a pension from a previous employer. While this will definitely help when you’re ready to “hang up your hat,” it might not be enough to live comfortably on. This means that you have to find alternate ways to survive in your non-working years, one of which is a small business owner 401(k).

What is a Small Business Owner 401(k)?

Often referred to as an individual(k), solo 401(k), uni-k plan, a self-employed 401(k), or a one-participant 401(k), the small business owner 401(k) is another option that small business owners can use to save up for a more comfortable retirement. Essentially, it allows you to put away money now so you can draw it out and live on it once you’re ready to stop working for good. Yet many small business owners don’t use them.

Steven Levin, President of Spending Plan Advisors says:

“I see far too many self-employed or small business owners that don’t take their retirement savings seriously. Whether it is because of limited resources, timing, or not wanting to worry about one more thing, that just don’t do it. I often hear the excuse, ‘How can I put money away for retirement when I have cash flow challenges, outstanding debt, payables, etc…?’ The simple answer is that, when it comes to retirement programs, small business owners need to think more like large companies. 

Imagine a growth company like Chipotle, Under Armour, Uber, and other high flyers telling their employees that their retirement plans are going away because they want to invest every penny of excess cash flow back into the company. I don’t think so! Aside from not being able to attract any new employees, it just is not good business sense. There needs to be balance.

Small businesses have similar retirement options available to them that larger companies have – it’s just about the scale. Some of my favorite companies offer fully packaged plans specifically for small businesses. Firms like T. Rowe Price, Vanguard, Fidelity, Schwab and more. You need to shop them, but they do make it easy. 

Do yourself a favor. Save some money. Tax free savings compounded over many years can really add up. Too many of my clients own businesses they worked hard to build, but they forgot to put some long-term savings away for themselves along the way. They wish they had.”

Makes sense, right? Are you ready to start working on your retirement now by setting up a 401(k) for yourself? Great! There are just a few things you need to know first.

What You Need to Know About Small Business 401(k)s

The one major eligibility requirement with a small business owner 401(k), according to Investopedia, is that only the business owners can be eligible to participate in order to set it up. Therefore, if you have employees who are eligible for participation, you’re not going to be able to go with this type of 401(k) plan.

As with any other 401(k), Internal Revenue Service (IRS) rules apply. Here is just some of what you need to know for the 2015 tax year:

  • Your annual elective contribution limit if you are under the age of 50 is $18,000
  • Your annual elective contribution limit if you are over the age of 50 is $24,000
  • Your non-elective contribution limit is up to 25% of compensation as defined by the plan, but it cannot surpass $53,000 if you’re over the age of 50
  • If you are self-employed, the maximum you can deduct is based on your net earnings minus “one-half of your self-employment tax, and contributions to yourself” (They even offer a worksheet if you need help figuring out this amount.)

Also, be aware that if, at year’s end, you have more than $250,000 in assets you typically have to complete and file Form 5500-SF in order to satisfy federal reporting requirements. What are the benefits of this particular plan?

The Benefits of a Small Business Owner 401(k)

One of the main benefits of having a small business owner 401(k) is, of course, having access to a certain sum of money at retirement. Sure, you can wing it and just hope that have enough cash to live on when you’re ready to enjoy life a bit, but having a 401(k) plan is often a better approach because then you’re assured the money is there when you’re ready for it.

Another benefit of having a self-employed 401(k) is that you can potentially borrow from your plan if you need to. Although this is an option that you may need in difficult times, some reasons to not borrow and make this a tool of last resort include the fact that you’re actually losing money in lost future growth, you lose your financial cushion should a bigger problem arise later, and it may just be a quick fix if you’re overspending as you’ll likely face the same issue again and again.

Of course, every small business owner’s situation is different, so you want to check with a financial advisor that you know and trust to see if contributing to or withdrawing from a small business owner 401(k) is the right decision for you. Then you can make an informed decision based on your particular circumstances.

What are your thoughts about a small business owner 401(k)? Feel free to share them below!

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by Christina DeBusk // Freelance writer, author, and small business consultant committed to helping entrepreneurs achieve higher levels of success.

Opinions expressed by contributors are their own.