February 28, 2024

27. Retirement Accounts for Small Business Owners

In this episode, I talk about the pros and cons of the main retirement account options for small business owners to setup to save on tax and diversify away from their business whether they have a small side hustle or are full time business owners.

Time Stamps:

  • 00:00-01:25: Introduction
  • 02:43-04:50 SEP IRA
  • 04:50-07:30 Solo 401 (k)
  • 7:30-8:56 401 (k)
  • 8:56-10:16 Cash Balance Pension Plan
  • 10:16-12:40 Conclusion



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Navigating Retirement Accounts: A Guide for Veteran Business Owners

In recent years, there has been a significant rise in the number of military members and veterans venturing into entrepreneurship. With statistics showing that around 8-9% of veterans become small business owners, well above the average population, it's essential to delve into the realm of retirement planning tailored to this unique demographic. Many Veterans will have a pension or disability income coming in that puts them in an outstanding position to start a business. 

Retirement planning is a crucial aspect of financial management, regardless of one's career path. However, for business owners, setting up retirement accounts takes a different approach compared to traditional employment. A business is likely the owner's greatest asset, and diversifying away from the business in part can have lead to better outcomes for owners. In this post, we'll explore various retirement account options, their pros and cons, and why they matter to veteran business owners.

The Importance of Retirement Accounts for Business Owners

When it comes to retirement, the landscape shifts for business owners. Unlike traditional employees who often have retirement plans provided by their employers, business owners need to take proactive steps to secure their financial future. Setting up a retirement account offers several benefits:

  1. Tax Savings: Contributions to retirement accounts can lead to tax savings, either in the present year or in future years, depending on the type of contribution and account.
  2. Diversification: Business owners can diversify their investments away from their business, reducing concentration risk in case the business faces challenges.
  3. Employee Satisfaction: Offering retirement benefits can enhance employee satisfaction and retention, crucial for businesses aiming for long-term success.
  4. Retirement Savings: Business owners have the opportunity to secure their retirement regardless of if or when the business sells by putting money into retirement accounts.

Retirement Account Options

Let's dive into four main types of retirement accounts for Veteran Business Owners:

1. SEP IRA (Simplified Employee Pension Individual Retirement Account)

The SEP IRA is ideal for businesses with few employees or sole proprietors. It's straightforward to set up, allowing employer contributions only. While it offers high contribution limits (up to $69,000 in 2024), it falls short compared to the Solo 401(k) in terms of flexibility and contribution options. The SEP IRA only allows for employer contributions, and not employee deferrals like a traditional 401(K). The downside of this account is it only allows for Traditional (pre-tax) contributions and not any Roth contributions. Another potential downside is that you have to contribute the same exact amount for every employee, so it may not be an optimal account for the business owner. The last potential downside is that having money in a SEP IRA makes the Backdoor Roth IRA strategy more difficult to execute and limits the upside of the strategy due to the IRS Pro Rata Rule. This account is usually suitable for those who may have some side hustle income while having a 401 (k) at their day job.

2. Solo 401(k)

Designed for sole proprietors or businesses with no other employees(typically the owner and spouse), the Solo 401(k) offers the highest contribution limits. The combination of employee and employer contribution limits top out at $69,000 in 2024. Business owners can contribute both as an employee and employer, potentially doubling contributions with a spouse's involvement for a total of $138,000. Another positive of this account is it allows Roth contributions, and since it is a 401(k), having pre-tax money does not complicate things with a Backdoor Roth IRA like it does in a SEP IRA. However, it requires more administrative work, maintenance, and may not be suitable for businesses planning to expand their workforce. This is the most powerful type of retirement account for the high income business owner with no employees other than a spouse.

3. 401(k)

The traditional 401(k) is suitable for larger businesses with multiple employees. While it allows for matching contributions and can enhance employee benefits, it comes with complexities like discrimination testing and limits on owner contributions. A 401(k) is going to likely result in a lower total contribution amount allowed for the business owner with the total elective deferral limit of $23,000 for employees in 2024. For business owners that have employees and don't want to make an equal contribution to everyone's plan like they would have to with a SEP IRA, a 401(k) might be a good fit.

4. Cash Balance Pension Plan

Geared towards high-income businesses, the Cash Balance Pension Plan offers substantial contribution limits upwards of $300,000 in 2024 depending on the age of the owner. allowing business owners to stack contributions on top of existing retirement accounts. However, it involves higher costs and administrative burdens, making it suitable for businesses with significant income and stability. This will likely be best for those solo business owners with very high income that are older in age. A younger business owner would likely benefit more from a Solo 401(k) with decades of compounding and other things that they probably want to be putting money towards.

Conclusion: Choosing the Right Path

Selecting the right retirement account depends on various factors, including business size, income level, and future growth plans. It might be optimal for one business owner to put their spouse on payroll and max out two Solo 401(k)s where it might be best for another business owner with 50 employees to setup a 401(k) plan to retain their staff. Whether it's maximizing contributions with a Solo 401(k), offering employee benefits with a traditional 401(k), or exploring advanced options like the Cash Balance Pension Plan, business owners must weigh the pros and cons carefully and choose the best option for them and the business both today and in the future.

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