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5 Retirement Investments, which one is for you?

We all want to be in control of our destiny. Retirement is a must when planning for the future for everyone but more especially for business owners. For business owners there’s two sides to this. On one hand, retirement plans are an extremely helpful way to draw new talent into the company. On the other hand, retirement plans are extremely important for business owners themselves to secure their future. After all, business owners can only rely on themselves to make sure they prepare an exit strategy for retirement. We will review 5 choices for retirement planning and the pros/cons of each.

The IRA, Individual Retirement Account AKA “Ole’ Reliable”

Everyone knows about the most common vehicle, the IRA. Individual Retirement Account says it all, but does it? The best thing about IRA’s is there is little to no cost to set these up. With tax season in the midst, you can easily set up an IRA with the bank you currently use and make prior year contributions to save some money on taxes. Keep in mind this does not mean you do not pay taxes on this money; it means you DEFER the taxes for a later date. What’s the point of that you might ask…? Well, the IRA was designed to:

  • Allow anyone who works to have the ability to save for retirement
  • To defer taxes to a point in time when the person will be earning less
  • Have more funds to grow during the investment period. 

Working years are normally a person’s highest earning years. This means while you are working you will be paying more taxes. Deferring the taxes to your retirement years means you will be paying less in taxes since your earnings will be less and you will be in control of how much money you distribute in those years out of your retirement accounts.

The IRA maximum contribution limit for 2020 and 2021 is $6,000. For anyone over the age of 50 you are allowed an extra $1,000 as “catch-up” contributions, a total of $7,000 for 2020 and 2021. There are income limits for this type of account and more details can be found directly on the IRS website. Another caveat to this type of plan is you cannot be currently participating in a company sponsored retirement plan.

The ROTH IRA, AKA “What’s the difference?!?”

Named after former Senator William Roth of Delaware, this is also an individual retirement account with the same contribution limitations as “Ole’ Reliable” above. The difference between a traditional IRA and a ROTH IRA is the ROTH does not defer taxes but is instead tax free upon liquidation. Meaning, you pay the taxes today on your contributions but when you retire and start pulling money from this account you will have no taxes owed. This is also beneficial because it means you will not pay any taxes on the growth of the account. As long as the IRS keeps their word, you gotta love that! 

In addition to the tax benefits, the ROTH also has higher income thresholds for the contributions which means higher earners who cannot contribute to traditional IRA’s can take advantage of the ROTH IRA’s. 

SEP Plan, Simplified Employee Pension Plans AKA “I need more”

Hopefully at some point you have gained enough steam where the limits of IRA and ROTH IRA’s do not satisfy the need to contribute more for your retirement. In this case business owners can opt to open a SEP Plan. SEP Plans allow for substantially much higher contributions while still maintaining very low costs. With these plans, per the IRS, one can contribute the lesser of a) 25% of the employee’s compensation, or b) $58,000 for 2021. So as a business owner with a W2 and some financial planning, one can really take advantage of this and stash much more away into your nest egg. With very minimal administrative costs and requirements this becomes a crowd favorite. On the down side while this plan can be used for employees and the business owner’s retirement, it does not come with all the bells and whistles of a full-blown 401k plan like allowing plan loans and the assets may not be used as collateral. In-Service withdrawals are allowed and will be included in income for persons over 59 ½.

Simple 401(k) Plan, AKA “Everyone join the party!

These plans are great for the employer who is ready to attract talent and retain valued employees. The requirements and administrative costs are more, but are not outrageous. Simple 401 plans allow for the employer to match up to 3%. This becomes a tax write off for the business but also a great incentive for the employee. Business owners receiving W2’s can also participate and see the benefits of the plan just as much as the employees. Max employee contributions for 2021 are $13,500 with a catch-up contribution of $3000 for those over 50. In addition to this, the employer can contribute 3% to all eligible employees. Employees are fully vested in all contributions, loans to the participant are allowed and hardship withdrawals add flexibility to the employees.

Now that you’re graduating to more features and benefits, so do the requirements and cost. While the Simple 401(k)’s “straight forward” benefit formula allows for easy administration, filing form 5500 is required for every plan. Allowing withdrawal and loan flexibility also means these items must be reported and accounted for, adding to the administrative cost. In the end the cost increase can be justified by the benefit of employee retention, talent recruitment, and tax deductions to the business.

Safe Harbor 401(k), AKA “Everyone join the party, but I want the whole cake!”

Business owners with great employees but even greater net income may want to look at this very carefully with their accountant/financial advisor. These plans do carry much higher administrative costs and usually require a third-party administrator to make sure the plan is complying with the IRS’ nondiscrimination testing. The third-party administrator will also be able to set certain requirements for contributions by the company which will increase the lion-share of the benefit to the owner while still providing all the bells and whistles to the employees.

By contributing either 3% of every eligible employees’ salary or 100% match of the first 3% of employee contributions and 50% of the next 2% as the business owner, you can then defer the max of $19,500 and reward your most valuable teammates (and yourself) with profit -sharing contributions up to the individual maximum of $58,000! This is huge, but as you can tell, more complicated than the other plans.

With all of these plans, it is important to note you should always seek the advice of a professional before making a decision on what is best for you. All of these plans carry early withdrawal penalties if money is taken out prior to the owner reaching 59 ½ years of age. In addition to the penalties, income tax will apply on most of these. Depending on the scenario you could be looking at 40%+ in taxes and penalties. So please, educate yourself when making these choices, but know that the sooner you make the right choice for yourself, the sooner you will be on your way to saving for a great retirement! At NaviPay we facilitate the funding of any plans you do setup or have already established. Please contact us for more information on getting your first 6 months of payroll at 50% off!

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