So you’ve realized your dream of owning your own business. Your customer base is growing and so are sales. You’re even being recognized as an expert in your field. The pride you feel when people appreciate and want what you have to offer is enormous. Maybe you even have a few employees. It’s a big deal to be responsible for their livelihood, but it also makes you feel successful.
Owning your own business comes with burdens you just didn’t have working for someone else. You have to deal with all the business regulations, tax issues and the ups and downs of your industry. No one gives you a regular paycheck. No one gives you any of the traditional benefits many larger employers offer. This part is stressful, and you are on your own.
One of the first things that falls by the wayside when you are self employed is saving for your own long term financial future. Your income might be irregular, and of course the business’ bills come first. However, like everyone else, you won’t be able to work forever.
Your first obligation is to yourself and your family. Your business will be more successful the more secure you feel, both currently and long term. Just because no one has provided you with a retirement plan, doesn’t mean you can’t save for the time when you will no longer be running your business. Yet few small business owners do. TD Ameritrade found that seven in ten business owners weren’t regularly saving for retirement. Almost one in three doesn’t save anything at all.
You invest anything extra in your business. Perhaps you’re counting on selling it, when you finally decide to slow down, to help make ends meet. While investments in your business help you earn more current income, few small businesses are worth much without their founders. BizBuySell.com reported that the median sale price for businesses sold in 2015 was just $199,000. So you may not be able to rely on the sale of your business to meet your retirement income needs.
The truth is small business owners may need to be saving even more than those with regular jobs. Business owners are frequently able to run the cost of automobiles and other expenses through their companies. Once you are no longer working, you’ll have to pay for these costs out of your savings. Also, you may be attempting to minimize your taxable income. This strategy is good for current cash flow, but you could be lowering the income Social Security counts for your benefit. So, your Social Security income may be lower than it would be if you had a corporate job.
Fortunately, the self employed have as good or better options for saving for retirement as the working masses. The IRS has created a number of tax advantaged account structures that allow business owners to stash away money for their futures. You can open up any of the following account types with a bank, discount broker, full service broker or mutual fund company. For a nice summary of all of the options check out this Department of Labor publication. In most cases your financial institution can help you with the required paperwork.
Roth IRA: If you are just starting out, and your business income is still small, an individual retirement account is a good way to save for yourself. A Roth IRA will allow you to contribute $5,500 per year. While the contribution is not tax deductible, as it would be if you went with a traditional IRA, the earnings on your contributions will be tax exempt, and upon retirement, after age 59 1/2, your entire withdrawal will also be tax exempt. If absolutely necessary, you can even withdraw your contributions (but not the investment earnings) without penalty before age 59 1/2. Whether you are allowed to make a Roth IRA contribution is subject to an income limitation, but it is fairly high.
Traditional IRA: This account is similar to the Roth IRA, but has more limitations. You can deduct your current contributions to the account ($5,500 per year), and your earnings grow tax free. However when you withdraw money from your account in retirement, the full withdrawal is taxable income. If you take money out before age 59 1/2, you will have to pay taxes on your withdrawal as well as a penalty. If you still have a balance when you reach age 70 1/2, you will be required to begin withdrawals, and pay taxes on them, whether you need the money or not. For most, a Roth IRA is a better option, but if your income is higher than the Roth limits, a traditional IRA is also a good way to go.
SIMPLE IRA: This is an IRA with substantially higher contribution limits, allowing you to save more. The contribution limit is $12,500 for employee contributions, and the employer can match that dollar for dollar. If you are the sole employee of your company, you can sock away $25,000 in total with your contribution as an employee of $12,500 and your matching contribution of $12,500 as employer. These plans are very easy to set up and have no annual reporting requirements. If you do have employees, you must contribute at least 2% or match up to 3% of their pay, and you have to contribute the same percent of pay to their accounts as you do to your own. Each person is responsible for making their own investment decisions, so you are not on the hook for that.
SEP: If your income has grown and you can contribute more to your retirement accounts, consider opening a Simplified Employee Pension plan. You can contribute up to 25% of your income or a maximum of $53,000 per year. These plans are easy to set up, and do not have the annual reporting requirements of the more traditional employer sponsored retirement plans. You do have to contribute the same percent of income for all of your employees with one of these plans, but the amount can vary from year to year if you need to make adjustments for business conditions. Here again, each person is responsible for their own investments.
These are the account types, but what do you do with the money once you’ve made a contribution? Consider investing in a target date mutual fund. Mutual funds allow you to buy into an entire portfolio of investments with a small dollar amount. Target date funds are structured to have the right kinds of investments for someone your age. They generally come in five year increments, and all you have to do is select the one for the year in which you want to consider leaving your company. For more information, see my article on these funds.
As a business owner, you have a lot on your plate. But that doesn’t mean that your own financial future should fall to the bottom of your stack of priorities. In fact it needs to be at the top. Contributions to your savings need to be treated like any other business expense. Your business can’t be healthy unless you are financially secure, both now and for the future.
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