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Taxes 2012: Retirement Planning for Small Business Owners

Choosing the right IRA and 401(k) plans can shave taxes and help secure financial futures

By Holly Kylen | April 4, 2014
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Holly Kylen is a financial adviser and retirement coach with ING Financial Partners, the broker-dealer of Voya Financial. She is an author of a seminar on retirement planning for women and serves on ING Financial Partners' Women’s Advisory Network Board.

For small business owners, tax season can be an ideal time to focus on retirement planning.
 
You have until April 15 to make Individual Retirement Account and profit-sharing contributions that you can deduct from your business income to help minimize your 2012 taxes. You also might take the opportunity to make adjustments to your company’s plan — or start a new one — for future tax savings.
 
As a financial adviser, I often meet with small business owners at this time of year to review their retirement strategy and contributions.
 
(MORE: 3 Mistakes to Avoid When Selling Your Business)
 
Just as growing a small business is no easy task, figuring out the right way to save for retirement isn’t a cinch, either.
 
The Big 3 Retirement Plans

There are three main types of tax-deferred retirement plans geared specifically toward small business owners: Simplified Employee Pension Individual Retirement Accounts (SEP IRA), SIMPLE IRAs and Solo 401(k)s. In addition, some entrepreneurs opt for traditional 401(k)s.
 
To determine which plan makes sense for you, you need to consider your time horizon, savings goals, desire to access the money before retirement and, if you have employees, their participation.

The Internal Revenue Service’s website is an excellent resource for details on the many nuances of retirement planning for small businesses.

But here are a few pointers:
 
If You Are a One-Person Shop The SEP IRA and Solo 401(k) are the two most popular plans for small business owners with no employees.
 
You still have until April 15 to open a SEP IRA for 2012. You can put away money for 2012 in a Solo 401(k) only if you set up the plan last year or before that.
 
With a SEP IRA, you can contribute up to 25 percent of your 2012 salary or 20 percent of your adjusted annual income, with a maximum contribution of $50,000 For 2013, the limit will rise to $51,000. 
 
A Solo 401(k) lets a business owner who is 50 or older contribute up to $55,500 for 2012 and $56,500 for 2013. Younger owners can put away up to $50,000 for 2012 plans and $51,000 for 2013. These amounts are the total of the employer’s contribution and the company’s profit sharing contribution.
 
A Solo 401(k) also offers a loan provision, giving you access to the money before retirement; a SEP IRA doesn't.
 
If You Have Employees Retirement planning gets more complicated for small business owners who have employees. Your choices are a SEP IRA, a SIMPLE IRA or a traditional 401(k).
 
If you’re interested in contributing to your employees’ plans as well as your own, a SEP IRA is a good way to go. You make the employer and employee contributions to this type of plan.
 
(MORE: Last Call to Get Your 2012 IRA Deduction)
 
There is a catch, though: You must contribute to all eligible employees’ plans and you have to contribute the same percentage of salary for everyone in the plan. For example, you could make SEP IRA contributions equal to 10 percent of each eligible employee’s salary, up to the contribution limit.
 
If you have fewer than 100 employees and want a retirement plan allowing employer and employee contributions, look into a SIMPLE IRA. It’s similar to a 401(k), but there is no loan provision and employees are immediately 100 percent vested.
 
With a SIMPLE IRA, employees under 50 can put in up to $12,000 in 2013, an increase from $11,500 for 2012. Those 50 or older can invest an additional $2,500 (up to $14,000 for 2012; $14,500 in 2013).
 
If you want a loan provision and a vesting schedule, you should instead go with a traditional 401(k). But this type of retirement plan costs more and requires additional administration work compared to an SEP IRA or SIMPLE IRA.
 
Roth IRAs and Roth 401(k)s
 
If you’re considering opening an IRA or 401(k), you’ll also want to decide whether to use a Roth version of the plan.
 
Like a traditional IRA or 401(k), earnings in a Roth grow tax-deferred. But you fund a Roth with after-tax dollars — your eventual distributions will be tax-free as long as you’ve had the plan for at least five years and you’re older than 59½ at the time.
 
I typically recommend to my small business clients that they put some portion of their retirement savings into a Roth plan.
 
How Much Should You Contribute?

You may be like many small business owners and have been so focused on your company that you’ve neglected to save for retirement.

If so, the first thing to do is sit down and figure out how much you need to save each year to meet your retirement goal. You may want to do this with the help of a financial adviser and your accountant. 

(MORE: Secrets of Claiming a Home-Office Deduction)

I recently met with a 50-year-old client, a freelance writer, to do just that. He had saved only $150,000 for retirement, having fallen into the trap of putting his business before himself. We figured out that he’d need about $500,000 to retire at 65 and maintain his current lifestyle. 

After our talk, he started a Solo 401(k), with a Roth component, and set up automatic $10,000 yearly contributions to help him reach his goal, assuming a 5 percent annual growth rate.

I explained that he could increase his contributions significantly in future years, if he had the money, allowing him to contribute up to $53,500 a year (these federal contribution limits could increase in the future).

Don’t Touch That Money

I caution my small business clients that money in their accounts should be viewed as off-the-table until retirement. Early withdrawals can incur ordinary income tax plus, if you’re under 59½, a 10 percent penalty.

And what is the end result of setting up and funding a small business retirement plan?
 
Well, nothing beats the happiness I see when my clients retire and there’s a bucket of money allowing them to do all the things they’d been dreaming about.
 
Securities and investment advisory services offered through ING Financial Partners, Member SIPC. Neither ING Financial Partners nor its representatives offer tax advice.