Retirement Plans For Business Owners – Be prepared for questions about SIMPLE, SEP, and individual 401(k) retirement account plans on the FINRA Tier 6 and Tier 7 exams. Continue reading
If you’re studying for the FINRA Series 6 or Series 7 exam, you’ll need to learn about the different types of retirement plan accounts. A retirement account may be an individual plan managed by the participant or the participant’s agent, such as an investment firm or trust bank. Or it could be employer-sponsored, meaning it’s organized and managed by the participant’s employer.
Retirement Plans For Business Owners
Private employers of any size and structure, from the largest C corporation to the sole proprietorship comprised of a self-employed individual, may establish and use an employer-sponsored retirement plan. For small business owners, retirement plans offer significant tax benefits and can help attract employees. Since there are many different types of retirement plans available to small businesses, it is important to understand the features of each option. The three plans that small businesses choose are individual 401(k) plans, SEP plans, and SIMPLE plans.
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A sole business owner can open a 401(k) if the business does not employ anyone else. The business owner creates a 401(k) plan like any other employer. Then, as an employee, the owner opens a 401(k) account within that plan.
Both employer and employee contributions can be made in an individual 401(k). The maximum employee contribution is the same as other 401(k)s. From 2022, this limit will be $20,500 per year, with a follow-on contribution of $6,500 for those aged 50 and over. As an employer, the maximum annual contribution is 25% of what the owner pays herself. The combined annual contribution (employee and employer) cannot exceed $61,000.
The business owner is allowed to employ her spouse and still use an individual 401(k) plan. The spouse can open their own 401(k) account using the business’s individual 401(k) plan. An individual 401(k) can be created whether the business is established as a corporation, LLC, or sole proprietorship. Self-employed people who have not established a business can also create an individual 401(k), although their contribution limits are calculated differently.
Unlike most employer-sponsored retirement plans, individual 401(k)s are not required to comply with ERISA (the Employee Retirement Income Security Act). This is a federal law that requires employers to give employees equal access to the employer’s retirement plan. These concerns do not apply when the business has no other employees.
What Retirement Plan Options Are Available For My Business In 2022?
Simplified Employee Pension (SEP) plans are IRA-based retirement plans for any size business, but they tend to favor small businesses. Under this type of plan, the business owner can make pre-tax contributions into IRA accounts set up for eligible employees and also for herself if the owner is self-employed.
The plan allows employers not to make contributions in years when business is bad, but if the owner makes a contribution for herself, she must also make contributions on behalf of her employees. When contributions are made, they must be made for all participants who did actual work during the year for which the contributions were made, including those over the age of 72 (the last feature is unique in a plan the SEP). The contributions of all participants must generally be uniform, for example the same percentage of the hourly wage.
The business owner can make contributions of up to 25% of an employee’s salary, or an annual maximum of $61,000, whichever is less. Only the employer, not the employee, makes contributions to the September IRA, but an employee is always 100% vested in their September IRA. Generally, the employer can take an income tax deduction for contributions made to each employee’s SEP. SEP contributions are not included on the employee’s W-2 statement for tax purposes. The rules for withdrawing funds are usually the same as any other IRA, meaning that withdrawals are subject to income taxes, and early withdrawals are usually subject to penalties.
The Savings Incentive Matching Plan for Employees (SIMPLE) plans are retirement plans for businesses with no more than 100 employees. With a SIMPLE IRA or SIMPLE 401(k), the employee can make pre-tax contributions to the plan. The contribution is expressed as a percentage of the employee’s compensation and is limited to $14,000 a year ($17,000 for employees age 50 and older). The employer is required to match these contributions up to 1% to 3% of the employee’s compensation or contribute 2% whether the employee contributes or not. The employer chooses the type of contribution (and if matching, the maximum percentage it will match). This option applies to all employees. An employer who chooses to make matching contributions is therefore under no obligation to pay 2% matching contributions to an employee who chooses not to contribute.
What Retirement Plan Is Available To Self Employed Individuals?
Any employee who previously earned at least $5,000 during any two years and is reasonably expected to earn at least $5,000 during the current calendar year is eligible to participate in this plan. Unlike a SEP plan, however, SIMPLE IRA distributions (withdrawal of account funds) in the first two years of the account’s existence if made before age 59 1/2 will incur a 25% penalty.
While the SEP plan is optional, in that the employer can decide when to fund the plan, funding a SIMPLE IRA plan is mandatory, regardless of the type of year the business had. A SIMPLE 401(k) works the same as a SIMPLE IRA. Both have the same contribution limits and are 100% proprietary from the start.
Traditional IRAs have characteristics in common with SIMPLE IRAs. For example, contributions are usually made with pre-tax dollars, must have earned income, and must be in cash only. Taxes on contributions and earnings are deferred until withdrawn, as long as withdrawals are made after age 59 1/2. Required minimum distributions (RMDs) must begin in the year the participant turns 72, although the participant may choose to delay the first payment until April 1 of the following year. Thereafter, RMDs must be taken by December 31 each year. Funds can be distributed as a lump sum or in periodic payments. If the account owner fails to withdraw an RMD or the full amount of the RMD before the deadline, the amount not withdrawn is taxed at 50%.
Anyone planning to become an enrolled representative by passing the Tier 6 or Tier 7 exam and helping customers with retirement plans needs to understand the complexity of retirement planning. The Solomon Exam Series 6 Study Guide and Series 7 Study Guide cover retirement plan accounts so you can be prepared for questions about this topic on exam day. Visit Solomon’s website to explore study materials for 21 different securities exams, including Series 6 and 7. There are a number of retirement solutions that can help you secure your future and your employees, but the decision-making process can be challenging.
Business Owners Need A ‘plan B’ For Retirement
A survey of nearly 2,000 small business owners in 2017 found that over a third (34%) do not have a retirement plan. The main reason for this cited (37% of those respondents) was that they were not able to generate enough income to save. Another 18% of business owners without retirement savings are looking at selling the businesses as a retirement plan.
Many small business owners avoid or don’t know the critical aspects of planning for their future. Here are some questions to ask yourself before deciding on a retirement plan:
With the help of Vanguard, we’ve put together a one-sheet that provides details and considerations for several small business retirement plans, including Small 401(k) Plan, Individual 401(k), Sep IRA, Simple IRA, Traditional IRA, and Roth IRA. .
Keep in mind that the state requires all employers in Oregon to facilitate OregonSaves if they do not offer a retirement plan to their employees. The deadline for employers with four or fewer employees is March 1, 2023. The rules are identical to a Roth IRA, in which employees contribute after-tax dollars to the plan and distribute savings tax-free.
Infographic] Retirement Plans For The Self Employed: A Comparison
If your business already sponsors or is looking to sponsor a 401(k) or other qualified retirement plan, you do not need to participate in OregonSaves but you must verify the exemption online. Exemption certificates are valid for three years from the date of filing.
Employers who do not sponsor a retirement plan or participate in OregonSaves by the designated deadline may be penalized $100 per affected employee. The maximum fine is $5,000 per year. More details can be found here: OregonSaves
Safe Harbor 401(k): The best retirement plan for small businesses with fewer than 100 workers to avoid a costly annual compliance test.
The responsibilities of owning and operating a small business can be overwhelming, but having the right retirement plan and advocates on your side can make all the difference. If you would like assistance in making the best decision for your business, we invite you to schedule an appointment on the calendar below.
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Jake Stewart, CFP™ Jake is a CERTIFIED FINANCIAL planner dedicated to helping clients achieve their goals according to their unique values. He builds comprehensive financial plans with an emphasis on retirement planning, tax mitigation, and long-term income management. He and his team effectively manage their clients’ financial landscapes by providing proactive advice and ensuring their clients’ peace of mind. If you are a business owner, it will set up
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