Retirement Planning for Business Owners

Many employees save for retirement by participating in their employer’s 401(k) plan and maybe even opening an individual retirement account (IRA) or Roth IRA for additional savings.

As a business owner, planning for retirement requires more effort, foresight, and strategy. In addition to navigating the wide range of retirement account options available to business owners, you must also ensure that your chosen strategy aligns with your overall estate plan.

Like any other working individual, business owners want to ensure that they will have sufficient retirement savings. They often pour all their time, resources, and extra funds into their business, assuming that it will serve as their retirement plan. However, relying solely on the future success of your business, instead of proactively saving for retirement, could be a costly mistake.

Retirement Account Options for Business Owners

Instead of relying on a single strategy, it is wise for business owners to diversify their retirement planning. Like any other important financial decision, having multiple backup options in place can provide greater security, flexibility, and tax efficiency over time. Business owners have access to a wide range of retirement accounts—far more than traditional employees—and each option comes with its own contribution limits, tax benefits, and administrative requirements.

Although the number of choices can feel overwhelming, working with a qualified tax or financial professional can help simplify the process. An advisor can evaluate your business structure, income patterns, and long-term goals to recommend the most appropriate retirement vehicles.

Traditional Retirement Plans for Business Owners

Opening a retirement plan such as a solo 401(k); a Simplified Employee Pension IRA (SEP-IRA); a Savings Incentive Match Plan for Employees (SIMPLE) IRA; or a pension plan can offer numerous benefits that allow business owners to grow their wealth outside of their business. A solo 401(k) is a retirement plan designed for self-employed business owners who have no employees other than a spouse. One of its biggest advantages is that the owner can make contributions in two roles—as both the “employee” and the “employer”—which can allow for significantly higher total contributions than many other retirement plans. Other plans, such as SEP-IRAs, SIMPLE IRAs, and pension plans, can cover both the owner and eligible employees, offering retirement savings and tax benefits for everyone involved. When a business owner contributes to one of these plans, they can lower their taxable income in the year the contributions are made. Additionally, because investments in these accounts grow tax-deferred, business owners do not pay taxes on earnings until retirement, allowing their savings to compound and potentially grow more rapidly over time.

The best plan for your business will depend on several key factors, including

●       How much income your business earns,

●       The stability of your business,

●       How many employees you have, and

●       How much you are willing to contribute on behalf of your employees.

Most tax-deferred retirement plans must comply with federal nondiscrimination laws, which are designed to ensure that benefits do not unfairly favor business owners or highly compensated employees—for example, by offering a plan that covers only the owners while excluding full-time staff. Only certain plans, such as a solo 401(k), are designed specifically for business owners with no employees and can legally exclude others without violating these rules. However, offering retirement plans to employees does not have to be seen as a drawback; many employees highly value the opportunity to save for their retirement, and your contributions may be rewarded with improved employee performance and long-term loyalty.

Self-Directed Accounts for the Bold Business Owner

Depending on how many employees you have and your comfort level with investing, you may also consider a self-directed retirement plan, which allows you to invest some or all of your retirement funds in alternative investments, such as precious metals, private lending arrangements, real estate, or interests in closely held businesses. These self-directed accounts may not be suitable for everyone. They require a high level of responsibility and risk tolerance, the tax rules governing them are complex, and penalties for mistakes can be severe. However, for the right person, they can open up a wider range of investment opportunities. Still, these should always be managed with the guidance of qualified professionals, such as a tax advisor, a financial planner, or an attorney experienced with self-directed retirement accounts.

Beyond Your Business: Traditional Retirement Accounts

Besides your business retirement plan, you may also be able to contribute to a traditional IRA or a Roth IRA. Doing so can serve as a way to add more money to your retirement, especially if you have maximized your contributions to the plans tied to your business. Additionally, contributing to an IRA outside of your business can help diversify some of your retirement savings and provide extra stability. Specific contribution limits apply across all IRAs, so it is important to be aware of how much you can contribute each year to stay compliant with Internal Revenue Service rules. The differences between traditional IRAs and Roth IRAs are as follows:

●       Traditional IRA contributions may be tax-deductible, depending on your income and whether another retirement plan covers you (or your spouse). Earnings grow tax-deferred until withdrawal in retirement.

●       Roth IRA contributions are funded with after-tax dollars, so they are not tax-deductible. Qualified withdrawals are tax-free in retirement.

Similar to the employer-sponsored retirement plans you can establish and participate in as a business owner, traditional IRAs and Roth IRAs can also be self-directed, allowing you to further expand your investment options beyond traditional stocks and mutual funds into assets such as real estate, private lending, and other alternative investments.

Healthcare-Related Savings Tools

As a business owner, you likely have a great deal of control over your health insurance decisions. If you are relatively young and healthy or are otherwise an infrequent user of healthcare services, consider pairing a high-deductible health plan (HDHP) with a health savings account (HSA) to boost your savings. HDHPs enable you to contribute pretax money to an HSA, which can be invested similarly to IRAs. Once you set up the account, you can withdraw your contributions and earnings tax-free at any time to pay for qualified medical expenses. However, withdrawals for nonqualified medical expenses are subject to income tax and a 20 percent penalty. After you turn 65, you can use the money for any purpose without facing the 20 percent penalty, though withdrawals for nonmedical expenses will be subject to regular income tax.

Funding Retirement by Selling or Transferring the Business

Many business owners dream of a financially lucrative exit from their company funded by selling, going public, or otherwise transferring their ownership interest for a substantial profit that reflects years of hard work and growth. A successful exit does not happen by accident; a business owner must first build and maintain a profitable enterprise that is attractive to potential buyers. From there, careful legal and tax planning is essential to minimize burdensome taxes and avoid the common legal risks that can arise during a sale. The net proceeds from selling a business often become a significant component of the owner’s retirement savings. When supplemented by one or more of the retirement accounts discussed above, such a strategy can create a strong foundation for long-term financial security.

Additional considerations exist for owners of family businesses who want to pass their company down to children or grandchildren. As with any other exit strategy, this approach still requires creating and sustaining a profitable enterprise. However, determining how the business owner will tap into the company’s value to fund their own retirement is less straightforward. Thoughtful planning for the transition to the next generation is essential. A business may be transferred to heirs outright or through a trust, which effectively moves ownership to them. Without additional planning, that transfer can limit or eliminate the owner’s ability to rely on the business’s value to fund retirement. Alternatively, the next generation or even key employees could buy out the owner’s interest or pay consulting fees during the owner’s retirement years, allowing the owner to draw on the business’s value while ensuring a smooth transition of control to the next generation.

The Importance of Estate Planning

Regardless of which retirement accounts or strategies you select, integrating them into your estate planning is crucial. Fortunately, several planning tools exist to help you do so effectively.

You can use basic estate planning tools to help ensure that your retirement assets transfer smoothly to your chosen beneficiaries. One strategy is to name your intended beneficiaries directly on your retirement accounts, allowing those assets to pass to them immediately without going through probate. Another option is to coordinate your beneficiary designations with your revocable living trust so that the funds flow into the trust and are managed and distributed according to its terms, helping to ensure greater control, protection, and consistency with your overall estate plan.

A more-advanced planning tool is an IRA trust, which can either be established as a standalone trust or included as a subtrust within your revocable living trust. This specialized trust is designed to maximize the financial benefits of inherited retirement assets, minimize the income tax burden, and provide robust asset protection for your beneficiaries.

Leverage the Team Approach

We can work with you and your team of professionals, including business advisors or consultants, tax advisor, and financial advisor, to develop a comprehensive retirement, business transition, and estate planning strategy. Working collaboratively, we can focus on setting aside assets for your retirement and preserving tax advantages while freeing you to do what you do best: build and grow your business.

Contact us today to develop a customized strategy tailored to your specific needs.