There are a number of options that retirement plan advisers can suggest to the self-employed and small business owners to help them save for retirement.
Serving this group is important, because a recent study by Manta, which helps small businesses market themselves, found that one-third of small business owners don’t have a retirement plan, says Rodger Parker, president and CEO of Parker Financial Group.
“And of those with a retirement plan, 21% have tapped into those funds to keep their business going,” Parker says. Since such a large percentage don’t have a plan, they definitely need the help of advisers, he says.
The two most prevalent retirement savings plans that the self-employed or small business owners use are Simplified Employee Pension Individual Retirement Arrangements (SEP IRAs) and Solo 401(k)s, says David Flores Wilson, founder of Planning To Wealth. Depending on how the business is structured, that is, whether it is a S Corp or a Limited Liability Corporation (LLC), the business owner will be able to contribute 20% to 25% of his salary to both of these options, or $57,000, a year, whichever is less, he says.
Chad Parks, founder and CEO of Ubiquity Retirement + Savings, likes Solo 401(k)s because like regular 401(k)s, “assets in the plan are covered under ERISA [the Employee Retirement Income Security Act], and the assets are protected from any liability, lawsuit or bankruptcy you might face. A SEP IRA doesn’t have the same protections.”
There is also a SIMPLE (Savings Incentive Match Plan for Employees) IRA, Parker notes. It permits contributions of $13,500 a year plus an additional $3,000 for those 50 and older, he adds. The only downside to these is that “they are a little more complicated due to accounting rules.”
In addition, there are Keogh plans, which can be set up either as a defined contribution or defined benefit plan, says Cheryl Heilman, president of Bankers Life Securities. Contributions are generally tax deductible and are set by the IRS each year up to a certain percentage of salary.
Those who do not think they can afford to save more than $6,000 a year should consider a “good old fashioned IRA,” Parks says. “If you can save more, the next level up are SEP IRAs. With these, you can save 25% of your salary or $57,000, whichever is less. SEP IRAs for the self-employed are a fine solution because they have high savings limits and are tax deductible. However, the limitation is tricky because it is a calculation of your net income. You have to pay Social Security and Medicare tax.”
The self-employed and small business owners should also take advantage of health savings accounts (HSAs) and 529 college savings plans, Flores Wilson recommends.
One of the main reasons the self-employed and small business owners don’t get around to saving for their retirement is because they are so focused on growing their business, says Chuck Czajka, founder of Macro Money Concepts. This is why he recommends using Section 7702 of the tax code to buy life insurance. “Money in the policies is liquid, and when you take the money out, it is tax free,” Czajka says. “The money will be available to the business owner while he is growing his business without being severely penalized and taxed.”
Another reason Czajka recommends this strategy over a qualified account is that taxes under the Trump Administration are low right now. “Rather than recommending to a 35-year-old to lock their money away for 30 years, I think it is preferable for them to buy life insurance and take it out when it is going to be taxed less,” he says.
The type of insurance he generally recommends is traditional whole life insurance that pays dividends through a rider called “paid up additions.” “With this type of insurance, it is self completing,” Czajka says. “Should you become disabled, the insurance company will continue paying your premiums, and you can use the death benefit while you are alive for long-term care and chronic illness.”
Parker also recommends indexed universal life insurance policies, which are linked to a stock index. “If the market goes up, you get the upside up to a cap,” he says. He also recommends fixed indexed annuities, which also are linked to a stock index. In the case of both of these options, he notes, should the market go into negative territory, the owner’s account offers zero gain.
For those who a “super high earners,” Parks recommends a 401(k) with a cash balance plan added on.
Recommending at least one of these options is critical, Heilman says. “With roughly a third of all working Americans expected to be self-employed this year, retirement savings options for entrepreneurs are becoming increasingly popular,” she says. “If you are self-employed, you need to be disciplined about saving for retirement because, oftentimes, you trade off your future to continuously invest in your business.”