How Does a Business Owner Start Saving for Retirement?
“I pray God may preserve your health and life many years” (St. Junipero Serra).
It is hard enough to determine how much to save for retirement when you are an employee, but what do you do when you are both the employer and the employee? There are so many parts to this question: How much should you save? What type of plan should you set up? What are the tax advantages? When should you start?
As usual, the answer to all those questions is “it depends”—which is partly why it can feel like a daunting task for many business owners. This, combined with the fact that retirement is often “far” in the future, leads many entrepreneurs to table it for later while they solve more immediate needs.
The other trap entrepreneurs fall into is thinking they will never retire because they love what they do. While your business may be your passion project, as you get older, you may no longer have the skills you need to run your business, only want to work part time, have a health issue arise that keeps you from being able to work, or simply change your mind. Saving for retirement gives you flexibility to change as your life evolves and as God puts new passions on your heart.
With that in mind, here are the answers to some common questions business owners ask about saving for retirement.
How Much Should I Save Per Paycheck?
The entrepreneur who encouraged me to write on this topic directly asked, “How much should I save per paycheck?” Most people are employed by someone else, and this question comes from their mindset. When they enroll in their company’s retirement plan, workers are asked to select a percentage or dollar amount to be contributed each paycheck into their retirement plan. Usually, there is a tool available from the plan provider to help the employee calculate how much they need to save to replace their income at retirement age. This calculation will vary depending on years until retirement, but usually 10% is the goal for contributions.
One of the main differences for business owners, however, is that many retirement plans also have company matches. This means that for up to a certain percentage of an employee’s salary, the company will double the contribution (an instant 100% return on those funds). While 10% makes sense for an employee, an entrepreneur needs to remember they are both the employee and employer, so their contributions may need to be higher. The other issue with thinking like an employee is that most entrepreneurs do not have a set salary. Even if they do have themselves on payroll with a salary, they also receive income from the profit of the company.
I know we all like black and white rules: “You should try to save 10% in your retirement plan” or, “You should try to save 15-20% of your income in various savings vehicles.” To be honest, there is a lot of wisdom in these rules; however, there is nuance. Let’s dig in a bit deeper.
Here is an example. Let’s assume:
You are 30 years old.
You will work for 30 more years.
You will live until you are 90 years old (30 years in retirement).
You have no savings right now.
Inflation will go up by 2% per year.
Your retirement savings will grow by 6% annually.
If you save $2,000 per month ($24,000 per year), adjust that savings with inflation (in year 2, you save $24,480), and make a 6% compounding annual return on your investments, you will be able to take out about $5,000 per month in today’s dollars (adjusted for inflation, almost $9,238 per month) and have a decent amount of money left when you are 90 years old (helpful in case you live longer, want to leave an inheritance, have unexpected medical expenses, etc.).
Hopefully, the example is helpful, but if you change any of the factors even by just one year, 1%, or $100, the results can change dramatically. You owe it to yourself, whether you are employed or an entrepreneur, to speak with a financial advisor to understand what is best for your situation.
What Type of Plan Should I Choose?
Once you have an idea of how much you want to try to save each year, you can start looking at plan types. They all have many rules and regulations. I’ll break down the most common options for entrepreneurs and their rules here:
IRAs/ROTHs
“IRA” stands for individual retirement account. In most cases, even employees of another company can contribute to an IRA account. There are income limits for eligibility if you do have a separate retirement account from an employer, so be sure you understand the rules.
If you are not part of another retirement plan, in 2024, you can contribute up to $7,000 into either an IRA or a ROTH IRA. Traditional IRA contributions will result in a write-off on your taxes. You will not pay tax on this money until you take it out in retirement. You’ll pay income tax on ROTH IRA contributions now, but you’ll never pay any tax (even capital gains tax) on any money that you take out of this account. It depends on your tax bracket and other factors to determine which option is best for you.
SIMPLE IRAs
SIMPLE plans are employer-sponsored retirement plans for small businesses or solo entrepreneurs. For 2024, the contribution limit for these plans is $16,000 per year. This number gets us closer to the needs of the example provided earlier. SIMPLE plans also require employer contributions, which you’ll need to take into consideration if you have employees. You can either match up to 3% of your employee’s contributions, or you can contribute 2% for every employee regardless of their personal contributions into the account.
SEP IRAs
SEP plans allow for even larger contributions, but all contributions are employer contributions. Employees are not allowed to contribute to these plans. Employers can contribute up to 25% of their employees’ (including themselves) salaries or $69,000 (whichever is less) in 2024. However, the percentage contributed needs to be the same for every employee (so, for example, the employer cannot contribute 25% for herself and only 5% for her employees).
Individual 401-Ks
Individual 401-K plans are similar to company 401-K plans at large employers, except the reporting requirements are much more manageable, because only businesses without employees can contribute to these plans. They allow for contributions of up to $69,000 per year (employee and employer combined) or 100% of compensation.
Selecting a plan is complicated. I have only listed some of the rules and requirements here. It is helpful to have an idea of what you want and then to discuss it with a financial professional. For most of these plans, you will need one to help you open and manage the plan anyway.
What Are My Tax Advantages?
Depending on the type of plan, there are different rules regarding what you can deduct from a business or personal tax perspective. Whether contributions are taxed now or later (when they are withdrawn) will impact your taxes and long-term planning. As you narrow down your plan type and savings goals, do some research, ask the right questions, and integrate the answers into your decision.
When Should I Start?
Ideally, you should start saving for retirement as soon as possible; however, the more practical answer is “as soon as feasible.” As an entrepreneur, you understand that business profit can ebb and flow a bit. You want things to be pretty stable before you commit to contributing to a plan regularly. Many plans offer flexibility regarding contribution decisions, but some require company matches. If you have employees, be sure you can afford these matches.
Retirement plans do have penalties if you withdraw from them early. Right now, the penalty is 10% of the amount you withdraw if you are under 59.5 years old. Understanding that you should not touch this money until retirement is important and may mean waiting a year or two before contributing to a retirement account—but that does not mean you cannot be saving in the meantime. It is always prudent to save in a taxable account that you have access to as soon as your profit is greater than your needs.
For most entrepreneurs, I recommend saving 50% of your profit in a taxable account and 50% in a retirement account for the first two to five years. This approach gives you some flexibility if unexpected expenses hit. After you feel established and confident, consider putting more money toward retirement. As a budgeting rule of thumb, try to live off 75% of your income, put 15% toward savings, and put 10% toward giving.
Again, “one size fits all” doesn’t really work in personal finance, but this breakdown should be a good starting point. Adjust your percentages as needed for your family and as God is calling you to. Discern what God is asking of you, and then consult a professional who shares your beliefs to validate your goals and decisions.
I wish I could give you an easy, simple answer, but it’s important to do your own research for your own situation. Hopefully, this article gives you some background information so you can come to the table knowledgeable. At that point, talk with a professional, and create a plan. God wants to provide for you right now and for your future. Be prudent, diligent, and wise, allowing Him to work in and through you in everything you do.
Erica Mathews is a CERTIFIED FINANCIAL PLANNER™ Professional with Financial Counseling Associates, a small, family owned, independent, financial planning and investment management firm. She is passionate about helping families and individuals build their wealth so they can live the lives they are made for. As a wife, mom of four, and businesswoman, she understands the complexities of family life and helps relieve the burden of financial stress with organization, a plan, and automation so her clients hit their goals. She lives in Colorado with her husband and four kids. They love everything outdoors including gardening, hiking, biking and simply exploring nature. If you would like to reach out to Erica, her email is erica@fca-inc.com.