Best Retirement Plans For Entrepreneurs
In this article, we discover 1) an introduction to preparing for retirement for entrepreneurs, 2) the importance of retirement planning for entrepreneurs, 3) most popular retirement plans for entrepreneurs, and 4) how entrepreneurs can plan for retirement.
A retirement plan is an investment and savings plan that would provide you with enough income to live independently after retirement. Against common perception, even entrepreneurs can have retirement plans and make their life as easy as possible after retirement. You, as an entrepreneur, might provide retirement plans for your employees, but you must consider choosing a good retirement plan for yourself as well.
A retirement plan often includes identifying income goals after retirement as well as decisions and actions to attain those goals. The plan further includes managing assets, implementing a savings program, estimating expenses and determining the source of income necessary for you to live without any financial woes after you have retired. Similarly, you also need to estimate future cash flows in order to ensure that you do achieve your retirement income goals.
As mentioned above, it is totally false on your part to think that retirement plans are only for government workers, police officers or teachers, etc. You need to think again. These are definitely the most common types of retirement plans, but there are many other types of plans that have been devised especially for entrepreneurs like you.
For example, I always recommend a Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA), one of the most common types of IRAs available to entrepreneurs in the United States. There are negligible administration costs if you happen to be a solo entrepreneur. If you have people working for you, all of you will receive the same SEP benefit.
Today, most entrepreneurs like to work beyond the typical retirement age. However, adequate financial planning for the long run can provide you with enough flexibility and control when you do decide to hang up your boots.
IMPORTANCE OF RETIREMENT PLANNING FOR ENTREPRENEURS
It is absolutely essential for you to take your retirement in your own hands and plan well in advance to enjoy a financially secure retirement. Here are some reasons why you need to plan for retirement:
- You Can’t Rely on the Government Welfare System: Although the government sponsors your retirement, it is not enough to meet your financial requirements once you retire. You need to remember that the ratio of covered workers to the number of beneficiaries has decreased significantly over the last few years. Similarly, people are living longer than ever before due to advances in healthcare. As a result, there is a greater strain on resources and governments nowadays have no other option but to reduce social security benefits.
- Find Possible Sources of Income Now: It is necessary for you to find all possible sources of income when you are still in control, to financially secure your post-retirement life. Once you retire, it will be difficult to maintain your current lifestyle as social security will replace only a fraction of the money you are earning while working. You have to supplement social security benefits by investing in retirement plans such as a 401(k), Individual Retirement Agreement Accounts, and other securities.
- Increasing Life Expectancy: Due to tremendous advancements in healthcare, people are living longer these days. Therefore, it is even more important for you to arrange enough financial resources to support yourself. It is also a bad idea to save only enough to last to a certain age. What if you live beyond that age? In this case, you might struggle to fund the “extra years” of your life. Therefore it is imperative for you to plan to live beyond the average life expectancy.
- Unexpected Medical Expenses: It is never the best option to rely on funds that you cannot control. Frequent health problems and increased medical expenses are an integral part of old age. If you don’t have adequate funds to cover these expenses, the golden years of your life may also become a nightmare because social security will only cover the bare minimum of your expenses. In this case, investing in long-term healthcare medical insurance can help you to prevent a lot of problems in the long run.
- Flexibility to Take Future Challenges: Life is full of surprises and unforeseen difficulties such as the deteriorating health of your loved one, a crumbling social security system and growing financial needs of your dependents. However, you will do yourself a big favor if you have secured enough to meet all of your future requirements without any hassle. This will provide you with peace of mind when you need it the most.
- Money Depreciates in Value: Considering the current inflation rate, the value of money is going to decrease considerably, say in next 30 years. Unless you plan properly, your buying and selling power will not be the same as it is today. It is important for you to recognize the true potential of saving in future terms if you don’t want to ruin your last years of your life struggling with financial problems.
MOST POPULAR RETIREMENT PLANS FOR ENTREPRENEURS
As an entrepreneur, it is your own responsibility to determine what type of retirement plan suits your particular requirements. It can be a bit confusing because there are plenty of options to choose from. In this regard, following are some of the most comment retirement plans you might consider.
The Small Business or Self-Employed 401(k)
A 401(k) is perhaps the most popular retirement plan not only among employees, but entrepreneurs as well. All the big banks in the United States offer different variations of this very plan such as the self-employed 401(k) or small business 401(k). In simple words, a 401(k) is all about investing a portion of your income in a mutual fund. There is a pool of management investments or contribution that helps your investment grow over time.
You can slightly reduce your tax burden as all the contributions are pre-taxed based. The major difference between self-employed and small business plans is that the former does not have any set up fee. For small business plans, set up fees are scaled to the size of your business and they cover multiple employees. Similarly, your selected institution will handle distribution of the profits and tax advisory services.
Simple IRA Plan
If your company has less than 100 employees, you might consider a Simple Individual Retirement Account (IRA) plan. Contributions are mostly done in the form of payroll deductions before the tax is paid. This plan requires both the employer and the employees to contribute some portion of their salary from each paycheck.
You, as an employee, must make a matching contribution dollar for dollar, and it can be up to 3% of the compensation you pay to an employee. On the other hand, you can make a fixed contribution for all eligible employees even if they don’t contribute to the plan. This contribution can be up to 2% of their respective compensations. You can include all new employees in this plan without their consent but must also give them the option to opt out.
There are many institutions across the country which can help you to establish a simple IRA for your business. Similarly, if you are already dealing with a certain bank, they might also have provisions to set up a simple IRA for you.
Retirement-Oriented Profit Sharing
Retirement-oriented profit sharing is an option for you if you cannot afford the fees of the 401(k) or you are not sure whether your business requires a simple IRA or not. The discretionary nature of the profit sharing plan also gives you the liberty to set any threshold level in terms of how the plan will be kicked in and how the profits will be distributed.
Most profit sharing plans are launched at the end of the fiscal year when all the expenses have been calculated. This simply means that you will not be working with pre-tax gross but have to deal with post-tax net profit. Profit sharing plans can reduce your saving efficiencies and increase tax expenses, but it will make employees feel more empowered to achieve the organizational goals as well.
Simplified Employee Pension (SEP) Plan
You can set up SEP-IRAs for all of your employees and yourself through a Simplified Employee Pension (SEP) plan. You have to make a uniform contribution for each of the employees, but it is not compulsory to make a contribution every year. If you automate the contributions and define them well, the pension plan can work perfectly both for you and your employees. In fact, missing a contribution to the SEP can also be an advantage for you, especially if your company is having a really bad year.
Again, almost all large financial institutions provide the facility of SEPs but its forms are a bit more complex as compared to IRA plans. Advisory services and fees vary from institution to institution. It is also pertinent to note that you are not bound to make any contribution as a package deal because this is essentially a pension plan. You must take a good look at the plans and make a decision accordingly. However, you have to maintain transparency so everyone knows what the scope of the pension plan is and how it is going to help them.
Individual Pension Plan (IPP)
More and more entrepreneurs are investing in Individual Pension Plans nowadays. Essentially a type of Defined Benefit Pension Plan, IPP helps you to secure your retirement in addition to increasing your tax-deferred retirement plan contributions. You make contributions according to a set formula based on the total years of your services and your age.
The first year contribution can be as big as $40,000 where your company has to contribute most of the money. However, this type of plan is well-suited to rich businessmen only because the annual contributions are $100,000 or more. The good thing is that the amount paid by the company will decrease as the contribution is a tax-deductible expense.
Insured Retirement Plan (IRP)
I would also suggest you try an Insured Retirement Plan, especially if you are still 10-15 years away from retirement. Similarly, if you are looking to acquire life insurance, it is better to invest in an insured retirement plan rather than choosing traditional insurance. As a matter of fact, insured retirement plans offer additional income through a life insurance that is, of course, exempted from all kinds of taxes. This type of retirement plan can also be a great option for you if you are already maximizing your contributions to Registered Retirement Saving Plans (RRSP).
Retirement Compensation Agreement (RCA)
You can also invest in the Retirement Compensation Agreement for the welfare of key employees of your company, including yourself. As the name suggests, RCA is a sort of agreement in which an organization makes a contribution to a third party that is commonly known as a custodian. These contributions are later delivered to the employee at the time of his retirement or termination.
As compared to other retirement plans discussed above, RCA is rather complex and unsuitable for every entrepreneur. However, it has certain benefits such as it helps you to avoid valuation requirements as in the case of IPP. Similarly, the tax will not be deducted from the contribution until the employee receives the benefits.
Money-Purchase Pension Plan (MPPP)
Both you and your employees make contributions to a Money-Purchase Pension Plan according to the terms of the agreement where the contributions are based on annual salaries. You can purchase a sort of allowance for your lifetime at the time of your retirement using the total pool of capital in your account. Obviously, the amount of capital varies from member to member based on their level of contribution and return on investment of those contributions. An MPPP depends upon your employees to ensure adequate levels of retirement income for all the members including the employers.
HOW ENTREPRENEURS CAN PLAN FOR RETIREMENT
There is nothing wrong in saying that most entrepreneurs lose sight of their retirement goals because they have so many duties to perform. However, there are many things you can do to make your retirement smooth and hassle-free as explained below.
Save Money for Retirement
You must start saving a substantial amount of money for your retirement right now because saving for retirement is not a sprint but a marathon. There are many businessmen who invest all their resources, energy and money back into their business and cut a sorry figure when they retire. You should not repeat this mistake as it is vital to start saving as soon as possible.
Choose a Retirement Plan
One of the easiest methods of saving money for retirement is to invest in a retirement plan. There are plenty of retirement plans for entrepreneurs, and you can choose one depending upon your particular requirements, obligations, and investment limits. Investing in a retirement plan of your choice is a decision will not regret.
Groom a Worthy Successor
It is never a wise idea to postpone the creation of a succession plan. Just like the retirement plan, you should start formulating a succession plan as early as possible even if your retirement is decades away. Grooming a worthy successor, whether it is your son, daughter or anyone else, means you and your business will always remain in good hands.
Formulate a Realistic Retirement Strategy
You should have a good idea about how many more years you want to work or when you are going to retire. You should not put off your retirement plan because retirement often comes earlier than you expect. Put all your requirements and ideas in black and white, as it will make things smoother for you. Do all things legally to make sure that you don’t jeopardize your retirement.
Prepare a Good Tax Strategy
There are many things you need to beware of when planning for retirement and the most important of them is the tax implications. For instance, you are eligible for a capital gains exemption (up to $70,000) if you are selling your business. It is always better to work with a trusted legal professional to better understand tax requirements and how to meet them.
Identify Sources of Your Retirement Income
It is foolish to think that you will fund your retirement simply by selling your business. The value of a business can depreciate over time or you may even decide to pass on the business to your heir. What you will do if anything like this happens? Similarly, money received from social security is never enough to live a post-retirement dream life. Therefore, it is important for you to identify all sources of income that can fund your retirement and make it pleasant rather than a nightmare.
Your business is just like your child, and it is always difficult to bid farewell to someone you love so dearly. It is a herculean task to set up a successful business, and it is even more difficult to sell it or pass it on to someone else. However, you have to go through this ordeal one day, and you can make the transition as smooth as possible with some careful retirement planning.