Business owners, including advisors, have options when it comes to retirement plans

Small business owners often pay themselves last, and saving for retirement is often not even on their to-do lists. But entrepreneurs who also happen to be in the business of financial planning have an added layer of responsibility as guides and role models —  they have to practice what they preach.  

“Until you’ve done it, you don’t know the deal,” said Eric Roberge, a certified financial planner (CFP) and the CEO of Beyond Your Hammock, a wealth management firm based in Boston. “It’s one thing to talk about retirement plans in theory and another when you can talk about the pitfalls and benefits of each option.” 

Call it walking the walk as well as talking the talk. “Launching my own financial planning business has completely changed the way I deal with business owners,” said Cody Garrett, the CEO of Measure Twice Financial in Houston. 

The type of retirement plan to choose as a small business owner depends mostly on your income level, but also on your age, plans for business growth, need for tax deferral and propensity for paperwork. Plans have different contribution limits and benefits that make them either ideal or not depending on where your business is in terms of growth. Whether you start with a SEP IRA, a solo 401(k) or dive into the complexities of a cash balance pension, your needs may shift over time, and, in fact, many small business owners journey through several kinds of retirement plans. That is, if they have a plan at all – only 13% of solo self-employed people saved in a retirement plan in 2019, according to a survey from The Pew Charitable Trust and the University of Michigan’s Health and Retirement Study. 

For example, Gretchen Behnke, a CFP at Pearl Financial Planning based in Plano, Texas, started out with an SEP IRA when she was a business consultant in her previous career, and then moved to a Solo 401(k) when her income increased and she wanted to defer more of it to reduce her taxes. Nikki Dunn, a CFP and the CEO of She Talks Finance, based in Austin, started with a Solo 401(k) and then added a cash balance pension plan. Eric Roberge started with a SEP IRA, moved to a Solo 401(k) and then opened up a 401(k) for his business when he added a full-time employee. 

All of those plans come with different contribution limits and administrative burdens. Here’s a rundown: 

This is the easiest of the plans to start, Behnke said, and about 3 million taxpayers had done so by the end of 2019, according to the latest available IRS data. You can add employees, but you have to put in the same percentage for them as you do for yourself. Most major brokerages have an easy-open option, which you will likely be able to do online with a few clicks. The money you put in is an employer contribution, generally limited to 25% of your income, or $61,000 in 2022, whichever is less (some adjustments to net earnings may be necessary), on up to $305,000 of compensation. 

“When I started financial planning, I was a career-changer, so I started with no clients and no income,” said Behnke. “In the beginning, the SEP IRA feels OK.. You’re not making a lot, so it feels like a fine ceiling to stay under.” 

Some may also want to consider a SIMPLE IRA, available to those with fewer than 100 employees, but the employee contribution limits are slightly lower than a SEP ($14,000 in 2022, with a $3,000 catch-up contribution for those over 50), and the terms are a bit more restrictive for owners in that you have to commit to a certain contribution level for the employer contributions.  

Solo 401(k) 
The main reason to jump to a Solo 401(k) is because one can generally make larger contributions. Savers can put in up to the IRS limit for employee contributions, which is $20,500 in 2022, with $6,500 in catch-up contributions for those over 50; then one can also make an employer contribution of 25% of net earnings, up to the $61,000 limit. So somebody making $100,000 could potentially contribute the whole employee contribution, and then up 25% of net earnings, for a possible total of $45,500, instead of just $25,000 in a SEP IRA. 

Tom Balcom, a CFP who owns 1650 Wealth Management in Lauderdale-by-the-Sea, Florida, moved into a Solo 401(k) when his business took off and he was looking for ways to decrease his taxable income. He contributes quarterly, as he is compensated by clients. He even goes a step further and then converts a portion of his savings to a Roth IRA. 

“My thinking is, I’m saving money by reducing my tax burden, so I’m using that savings to convert it,” he said. 

ICI and other sources don’t track the number of solo 401(k)s. But most major brokerages offer the plans, along with independent providers such as Rocket Dollar and Ubiquityx. Those who choose this option need to file a plan document outlining the rules adopted on things like the vesting schedule and the beneficiaries, but the administrator should have a template available. One can select a provider based on the desired features — for instance, not all plans have a loan option. Note that these plans are only for the solo practitioner plus a spouse; employees cannot be added. 

“I don’t think it’s that difficult a process at all. If you want to get the tax benefits and to max out what you can, I think the paperwork is worth it,” said Julie Hall, a CFP at Vision Capital Partners in Ann Arbor, Michigan.  

Solo Roth 401(k)
Some Solo 401(k) providers allow a Roth option for the employee contribution, where funds are added on a post-tax basis and the growth is tax-free. The employer contribution is still tax-deferred. The decision on whether to seek a Roth product depends on personal tax situations. For somebody like Paul Winter, a CFP at Five Seasons Financial Planning in Salt Lake City, Utah, it wasn’t enticing because his main concern is current tax deferral, and he already converted a portion of his retirement funds to Roth. But if a tax situation would benefit from the tax break later on in life when one’s income bracket might be lower, it might be worth it, he added. 

Cash balance pension plan
When one wants what Balcom calls “basically a 401(k) plan on steroids,” then turn to a cash balance defined benefit pension plan. Many advisors open these in conjunction with a Solo 401(k), maxing out that first, and then deferring the remainder above the $61,000 limit into the pension plan. One can contribute more to a cash balance plan because instead of capping contribution limits at  those for qualified defined contribution plans, an actuary from a third-party administrator defines what the benefit will be based on age and income, and then assigns a contribution limit.

With a spouse on the plan, which is the way Winter does his account, the amount could be in the six figures. The start-up cost runs around $6,000 to $8,000, and ongoing maintenance can be several thousand a year, added Dunn, but it can be worth it for the larger contribution amount. 

“The tax savings need to outweigh the costs to set up,” she said. 

Despite the pension name, the end-game is not an annuity-like monthly payout. The funds are typically invested in mutual funds and exchange-traded funds under one’s own direction. Winter, for one, said he plans to roll his pension plan into an IRA at retirement. 

Traditional 401(k)
When it comes time to add employees to a growing firm, plans designed for an individual might not remain the best option. Nicole Sullivan, a financial planner with Prism Planning Partners in Libertyville, Illinois, started out in financial planning as a W-2 salaried employee with a traditional 401(k), then went out on her own and started a SEP IRA and also contributed to a Roth IRA. She incorporated as an S corporation — a form of entity that doesn’t itself pay taxes but instead passes its income through the owner, who pays ordinary rates — in 2022. She also decided to open a 401(k) plan for herself, her partner and two employees, with both traditional and Roth 401(k) options. 

“When we got employees, we realized we had to offer them something,” Sullivan said. “We did want to make this right by all of us.”