Why Small-Business Owners Can’t Retire

4 min read

Tyler Lang, CFA, is Founder & CEO of Journey Advisory Group. follow Tyler on LinkedIn.

Data from recent surveys among small-business owners reveals some alarming developments:

• Only 1 in 4 business owners have a financial strategy for retirement in the form of a written plan.

• Post-Covid, 17% of self-employed workers now expect to either retire later than planned or not at all.

• 37% of small-business owners don’t think they make enough profit to save for retirement

When asked why they are unable to save for retirement, responses ranged from “lack of profits to save for retirement” to “I don’t see the need to save for retirement.”

Living with risk is inherent in small-business owners; they embrace risk as part of bypassing a corporate career. But the attributes of independence, optimism and confidence that are hallmarks of successful small-business owners are the same traits that cause them to ignore or delay planning for their future. Having little or nothing put aside for retirement should scare them, but they treat the idea of ​​retirement with the same indifference as postponing annual physicals. Many ignore planning because they are convinced that reinvesting any profits from the business will make it that much more attractive to prospective buyers someday, and that will take care of their retirement needs.

Another issue for these small-business owners is miscalculating how much they will need to maintain their lifestyle in retirement. They tend to underestimate future expenses and overestimate future income. Two years ago, as an advisor alerting them about the perils of inflation and diminished purchasing power, my caution was typically met with a shrug. Today, inflation is one of their biggest concerns, and rightly so. When the CPI jumps from 1% to 7% in a single year, even busy entrepreneurs take notice.

As a fellow small-business owner, I believe it’s critically important to avoid procrastinating and treat retirement planning as a priority. There are a number of attractive retirement plan options available, including:

SEP-IRA: This is the least complicated method of making tax-deferred retirement contributions for small-business owners with 20 or fewer employees. Funded solely by employers, contributions are made directly to an IRA or individual employee annuity. For 2023, the annual employer contribution limit is $66,000 or 25% of compensation. Eligible employees receive the same percentage.

• Solo 401(k): This is the best option for businesses with no employees other than a spouse owner, as well as self-employed individuals. Contribution limits are the same as the SEP-IRA.

• 401(k) plans: Businesses with employees have additional 401(k) plan design options, including traditional plans, safe harbor plans and advanced profit-sharing plans. Funded by both employer and employee contributions, eligible employers may receive tax credits of up to $16,500 over the first three years to offset the startup costs.

Offering a 401(k) can also be an effective way of attracting top talent. Vesting schedules provide incentives for retaining vital employees. Annual contribution limits for 2023 are $22,500 for employees (not including matching employer contributions). Those aged 50 and older can contribute an additional $7,500. The total employer-plus-employee contribution is $66,000.

• Safe harbor 401(k): This type of 401(k) exempts employers from the nondiscrimination testing required with a traditional 401(k) plan. One caveat is that employer contributions to employees’ accounts must be fully vested when made. Contribution limits are identical to a traditional 401(k).

• Roth 401(k): This type differs from a traditional 401(k) in that contributions are made with money already taxed. Account earnings grow tax-free, and no taxes are due upon withdrawals in retirement.

Choosing the best retirement option depends on individual circumstances, the number of employees and other factors, and is best accomplished in partnership with an experienced advisor. The most important aspect of planning for retirement is getting started. You are no doubt aware of the advantages of the compounding of interest over time. Simply put, the sooner you start saving, the more time your retirement account will have to grow.

In addition to helping ensure you enjoy a fulfilling retirement, taking care of your key employees is a smart business practice that will make your working years more pleasant and profitable.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.


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