Starting your own business as an entrepreneur puts you at significant financial and personal risks. However, there is one risk – not saving for retirement – that you don’t have to subject yourself to. Whether you run your business alone or have a few employees at your back, there is a 401k plan available that can help you ensure that your golden years are stress-free.
Just because your business is a one-person operation doesn’t mean you (and your spouse) have to miss out on the benefits of saving for retirement with a 401k account. You can set up an individual 401k (also known as a one-participant or solo- 401k) plan through your bank or another financial institution in order to contribute pre-tax funds into a savings, mutual fund, or money market account of your choosing.
As both employer and employee, you can make two kinds of contributions to your 401k account.
- As employee, you can defer up to 100% of your earned income into your account, up to $17,500 per year (or $23,000 if you are over age 50).
- As employer, you can contribute a further 25% of your earned income into the account. The total contributed amount cannot exceed $51,000 per year.
- These contribution limits are current as of the 2013 tax year. The limits are now indexed to inflation and will increase in $500 over time.
As with most other retirement plans, there are withdrawal limits. You may be subject to taxes up to or exceeding 10% of the withdrawal amount for withdrawals made before age 59 ½. However, when setting up your individual plan, you can tailor these limits to allow you early access to your funds through loans or hardship distributions.
Business Owners with Employees
Offering a retirement plan as part of your employee compensation plan can help you attract talented and qualified employees to work for you. In many cases, you can offset offering a lower salary by including good benefits, including a 401k plan. You can deduct the cost of the plan from your business’s taxes each year, and your employees can put aside tax-free money in preparation for retirement.
- A traditional 401k plan enable employers to make contributions on behalf of employees, match employee contributions or both. Employees can make their own contributions through pre-tax payroll deductions. Employers are subject to annual nondiscrimination testing that ensures benefits are proportional among all employees. Employer contributions are subject to a vesting schedule (the length of time that must pass before employees attain full ownership of employer contributions).
- A safe harbor 401k plan is similar to a traditional 401k. The differences include: employer contributions are fully vested when made; it is subject to far fewer complex tax rules, making it less of a burden on employers; and it is exempt from nondiscrimination testing.
- An automatic enrollment 401k plan allows employers to deduct a certain amount from employee wages and contribute it to a retirement plan on the employee’s behalf. The employee must choose to opt out or contribute a different amount than that chosen by the employer.
- The SIMPLE 401k plan was created specifically to make setting up employee retirement accounts easier for small businesses (those with fewer than 100 employees who receive at least $5,000 in compensation each year). It is not subject to nondiscrimination testing, and is a more cost-efficient way to offer retirement benefits to your employees.
While you can certainly set up your 401k accounts on your own, it’s best to ask the advice of your lawyer or business banker before making a final decision. An expert can help you make sure that the 401k you choose is right for your business’s financial plan, right for you and your employees, and easy to administer.