Unlike employees who can lean on HR departments and automatic 401(k) deductions, small business owners are in charge of their own retirement savings. That might sound intimidating, but it actually allows you the flexibility to design your own retirement plan and unlock serious tax savings.
In today’s post, I’ll explain how much you should be saving for retirement and how to use those savings to lower your tax bill now while also building long-term wealth.
How much money should I be saving for retirement?
Many of my small business owner clients ask me to help them figure out what’s “left over” at the end of the year so that they can put that money into a retirement account.
While I can understand why some may view their retirement savings as an afterthought or something to be done after all of the bills are paid, I strongly recommend that everyone look at their retirement savings as necessary and schedule contributions all year long. Not only does this ensure that you don’t forget to save, but it also reduces your tax bill (more about that in a minute!).
When thinking about how much to contribute, the number you should really start with is how much you want to have saved when you retire. Once you have a realistic amount that you think would allow you to live comfortably in retirement, then you can work with your accountant or financial advisor to determine how much you should be saving each year until that time.
If you’re looking for a number to get you started, many financial advisors recommend that you save 15% of your pre-tax income each year, and that number makes sense for most small business owners too.
If 15% sounds like a big number to you, remember that small business owners must often be even more aggressive in their retirement savings plan than employees since small business owners don’t have an employer to match contributions like other employees might.
What kind of retirement savings accounts can small business owners use?
Here’s where small business owners actually have an advantage. You have access to retirement plans with much higher contribution limits than typical employee plans. In addition to traditional and Roth IRA accounts, there are 3 other account types that you should consider as a small business owner:
| Account Type | Best For | Contribution Limits (These Are Adjusted Slightly Each Year) | Benefits |
|---|---|---|---|
| SEP IRA | *Small businesses *Businesses with variable income |
Max contribution ~$70,000 annually Employer contributes up to 25% max of earned income (must contribute same percentage for all employees) |
*Reduces taxable income *Grows tax-deferred *Can be adjusted each year *Low administrative hassle |
| Solo 401(k) | *Small businesses without employees (or just spouse as employee) *High earners trying to catch up or save aggressively |
Max contribution around ~$70,000 annually
+Employee can contribute up to ~$23,000 annually +Employee can contribute catch-up amounts if over age 50 |
*If over 50, allows catch-up contributions to supercharge retirement *Contributions not limited to 25% of earned income *Reduces taxable income *Grows tax-deferred |
| SIMPLE IRA | *Small businesses with employees | +Employee can contribute up to ~$17,000 annually +Employee can contribute catch-up amounts if over age 50 +Employer either makes a matching contribution up to 3% of earned income for every employee or a nonelective contribution of 2% for all employees |
*Simpler and easier to administer than a full 401(k) |
How does saving for retirement also save me tax money?
Of course, your retirement savings will fund your future, but it’s important to understand that planning for retirement is actually a current-year tax planning tool!
Here’s the key: For every dollar that you contribute to a pre-tax retirement plan, you reduce your overall income, which lowers your tax bill right now.
For example, if you earn $180,000 and contribute $40,000 of that to a Solo 401(k), your taxable income drops to $140,000. That drop in income could easily save you between $9,000 and $12,000, depending on your filing status and deductions.
What if I haven’t been saving enough for my retirement? Can I catch up?
If you started saving late, then you’re not alone. This is true for many people, especially entrepreneurs who needed some time to get their business off the ground before the cash started flowing.
Just run the numbers, and put in as much as you can until you’re where you want to be. If you’re over 50, definitely take advantage of the catch-up contribution limits that are usually available for all plan types except SEP IRAs.
What tax advice do you have for small business owners saving for retirement?
- Don’t wait. The biggest mistake I see is business owners thinking they’ll save for retirement once “business settles down” or that they’ll sell their business and use that money as their retirement fund. Take it from me, businesses rarely settle down, and while it would be amazing if you could just sell your business and enter retirement seamlessly, those plans don’t always work out. Don’t put off saving for retirement. Instead, treat it like a required expense that’s just as important as rent or payroll.
- Set up a system. Once you’ve figured out how much you need to save, make sure to set up a system where your money automatically moves into a retirement account. I recommend you make a monthly or quarterly contribution.
- Schedule an annual check up. Set up a calendar reminder to adjust your contribution amount annually or to discuss the amount each year with your accountant. During your check up, make sure you ask these questions:
- How much annual income do I want to have during retirement?
- How much do I need to have saved when I retire?
- Am I saving enough to hit my goals in retirement?
- Should I be contributing to a SEP IRA or a Solo 401(k) instead of a traditional brokerage account?
- Am I intentionally using my retirement contributions to reduce my tax bill as much as possible?
- Am I saving consistently?
Abridged by Amy
Saving for retirement is one of the most important financial decisions you can make for your business, and it’s not just about your future. As I’ve explained, saving for retirement is also a tax-saving strategy that you can’t afford to miss out on. Just know that the sooner you design a retirement savings system that works for you, the less painful and stressful it will be.
If you’d like help determining the right contribution amount, choosing the right type of retirement plan, or running the numbers to make sure you’re maximizing your tax savings and your retirement contributions, consult with a CPA who understands small business cash flow.
