It’s often thought that one of
the major disadvantages of being a small business owner is the lack of employer
provided benefits. Along with health insurance, the biggest of these benefits is
a retirement plan.
However, small business
owners have excellent options on the retirement front. You can choose a self-directed IRA or a SEP
IRA and cover the retirement side of your benefits quite nicely.
The Advantages of a Self-Directed IRA
With a traditional IRA, you
can contribute up to $5,500 to the plan each year ($6,500 if you’re age 50 or older), and
invest it virtually any way that you want. Investment income earned on the plan
is always tax-deferred. And as long as you have no employer-sponsored
retirement plan, the full amount your contributions will be deductible from
your income.
One limitation that may
apply to a small business owner is if he or she has a spouse who is covered by
an employer plan. If that’s the case, there may be limits on the amount of the contribution that
is tax-deductible.
Even if your spouse is
covered, you can still take a full deduction up to a modified adjusted gross
income (MAGI) of $183,000. You are also eligible to take a partial deduction up
to a MAGI of $193,000, after which your contributions will no longer be
deductible.
Whether or not your
contributions will be deductible, here are some of the major advantages:
Simplicity. An IRA is virtually the
easiest type of retirement plan to start and to maintain. You simply fill out
some paperwork – often most of it done online – send in
your contribution, and go from there. There are no significant paperwork filing
requirements on your part, nor are there any involved reporting issues. You can
virtually handle it like a bank account, except that it’s actually a retirement
account.
Choice of
trustee. Unlike an
employer-sponsored retirement plan, where the trustee is a given, you can
select any trustee that you want. This can be a bank, a brokerage firm, or even
a mutual fund. And as such, you can choose the trustee that offers the lowest
fees for the account.
Unlimited
investment selection. This is
where the term “self directed” enters the picture. Since you are free
to choose the trustee that you want, you can choose one that offers any
investment selection that you like. And with very few exceptions, you can
invest in just about anything you want with a self-directed IRA.
Complete
portability. Your IRA
is your IRA, and wherever you go, it goes with you. You can move it from one
trustee to another, or you can even roll it over into an employer-sponsored
401(k) plan (if that plan permits such a move) in the event that you decide to
give up being a small business owner, and decide to take a regular job.
The Advantages of a SEP IRA
If an IRA is an excellent
retirement choice, a SEP IRA is even better - especially for a small business
owner. We can think of the SEP IRA as a regular IRA on steroids. It has many of
the same advantages, including tax deductibility of contributions and
tax-deferred investment earnings. But in almost every other way, the SEP IRA is
a superior retirement vehicle.
Here are the specific
advantages of a SEP IRA:
No limits on
the tax deductibility of your contributions. Unlike a regular IRA, you will not lose the
deductibility of your contributions even if your spouse is covered by
employer-sponsored retirement plan. A SEP IRA is considered to be a retirement
plan specifically attached to your business.
Higher
Contribution Limits. This is
probably the biggest advantage of a SEP over a traditional IRA. Where a
traditional IRA is limited to $5,500 per year, you can contribute up to $53,000
with a SEP. You can contribute as much as 25% of your net income (effectively
20%, since your contribution must be based on 25% of your income, reduced by
the amount of your SEP contribution). But that’s nearly 10 times higher
than what it is for a traditional IRA.
Choice of
trustees. Like a
traditional IRA, you can open up a SEP plan with the trustee of your choice.
Unlimited
investment selection. Same as
with an IRA, you can invest in just about anything that you want, or that is
available through the trustee that you choose the whole the account.
Can extend the
plan to cover employees. This is
probably the second biggest advantage that a SEP has over traditional IRA. If
you have employees, or plan to hire some, you can include them in your SEP
plan. Each employee will be required to open up an individual SEP account. This
will allow you to begin extending retirement benefits to your employees, which
could be an important advantage when it comes to hiring the right people.
Whether you choose a
traditional IRA or a SEP IRA, you will not be able to begin making withdrawals
from either account until you reach the age of 59 ½. If you do so sooner,
the amount of the withdrawals will be subject to ordinary income tax, plus a
10% early withdrawal penalty tax by the IRS.
You will also be required
to begin making Required Minimum Distributions (RMDs) from either plan no later
than age 70 ½. But this requirement is one that is imposed on nearly
all tax-sheltered retirement plans.
Other than the fact that
you will be able to make much larger contributions to a SEP IRA than to a
traditional IRA, you can’t go wrong with either plan. If you are a small
business owner, the only mistake that you can make is to not participate in a
retirement plan of some sort. And either of these will be an excellent choice -
with the nod going to the SEP.
Author Bio
Donny
Gamble Jr. is an online entrepreneur that runs a financial blog
called Personalincome.org. He also is a frequent contributor to SmallBizTrends,
Huffington Post, and many other personal finance blogs. Follow him on Twitter @donnygamblejr
