4 Alternatives To 401(k) For Small Businesses

Posted by Jake Sadler on May 10, 2022

4 Alternatives To 401(k) For Small Businesses

Financial planning can seem complicated enough as an individual, let alone if you’re a small business owner. As a business owner, the line between your personal and company finances are often blurred.

In this article, we’ll discuss three financial planning tips for small business owners, as well as four alternatives to 401(k) for small businesses, to help you navigate the financial balancing act of entrepreneurship.

Are you looking for a customized financial plan for your small business, complete with tax advice? That’s our wheelhouse. Schedule a call with us at Bay Point Wealth today to find out how we can help.

3 Financial Planning Tips For Small Business Owners

Small business ownership is at a record high in America, with 5.4 million applications filed to start new companies in 2021 alone. Small businesses make up 99.9% of companies nationwide. Yet, entrepreneurship can be a lonely endeavor, and it’s important to be able to access the right advice, particularly when it comes to your finances.

Depending on the way your business is structured—whether you’re a sole proprietor or you own an incorporated company—financial planning can be especially complex. In either case, every financial decision you make in your business and your personal life has a ripple effect, spilling over into the other area of your financial affairs.

At certain points in time, every business owner has to choose to prioritize their personal life over their company, and vice versa. When you’re focused on your business, it’s crucial not to lose sight of the personal aspects of your life, including your finances. It can be tempting to go all in on your business savings, for example, but it's key to fund your personal objectives as well as those of your business.

Here are a few tips that will help you manage the financial side of small business ownership and allow you to honor yourself as an individual at the same time:

1. Keep your eyes on the big picture.

Remember: Life will continue even after your chapter in business has come to a close. For instance, you may choose to sell the business at some point. This is why it’s essential to have a plan for your personal financial future.

2. Pay yourself first.

This advice applies to everyone, but particularly small business owners, for whom this is toughest to do. You’ll be tempted to pay yourself last, taking what’s left over after all the monthly expenses have been covered. Or, you may be willing to take home very little pay so you can put more money into your company. However, it’s critical to allocate a portion of money for your personal needs so you can pay important bills such as your mortgage, car payment, and more..

3. Grow your business methodically.

It’s admirable to want to shoot for the moon with your business goals, however, doing so can come at a great cost to the personal side of your life. Instead, we recommend taking a prudent and methodical approach to growing your company, with a full understanding of the financial decisions you need to make to reach your objectives. This includes determining what kind of savings and retirement accounts are right for your business, which we’ll dig into next.

4 Alternatives To 401(k) For Small Businesses

Consider Pros and Cons of a 401(k) First

For many small businesses, establishing a 401(k) may seem like a daunting challenge. It may be hard to find good resources to get started, and 401(k) plans are often misunderstood as being very expensive, complicated, and limited only to larger companies.

The reality today is that even if your company is a two-person shop, a 401(k) plan can work just as well for you as it can for a 1,000-person enterprise.

Implementing a 401(k) enables you to access good investment choices, and administrative costs have been decreasing over time. 401(k)s also provide a great deal of flexibility. You can design your plan to be as simple or as complex as you want, and employees of all ages can participate. For example, if an older business owner and younger employee are both enrolled in the plan, it can be set up to favor the owner with a profit-sharing element. In this way, 401(k)s allow you to get creative in an affordable manner.

Pro Tip: Financial planning and tax planning go hand-in-hand for small business owners. You can take advantage of important tax benefits by having a 401(k). If you’re making employer contributions for your staff, you can get a tax write-off for that money. You can also cover the plan’s administrative costs through tax write-offs.

You may not necessarily need an alternative to a 401(k) plan. However, you may face circumstances that limit the effectiveness of a 401(k) vs. the alternatives. For example, if you are a sole proprietor rather than an incorporated business; if cash flow is highly variable from year to year; or if you have a high turnover of part-time employees.

For businesses where a 401(k)’s cost, design, and administrative responsibility may not be the best fit, here are four options to consider:

1. SIMPLE IRA

It’s a hefty acronym, but SIMPLE simply means Savings Incentive Match Plan for Employees, and you may already be familiar with the term IRA (Individual Retirement Account).

This kind of plan can be a good savings vehicle for businesses with fewer than 100 staff members. It’s fairly easy to set up and the costs tend to be lower than a 401(k), which can be attractive. However, employers do have a mandatory requirement to make either a 3% matching contribution or a 2% non-elective contribution for each eligible employee.

The SIMPLE IRA is also not necessarily “simple” in nature, particularly from the employee’s point of view. It is not uncommon for many participants who have a SIMPLE IRA to not know how the plan works or the benefits of participating, as the SIMPLE is far less common than typical 401(k) plans that employees may be familiar with.

The SIMPLE has lower contribution limits than a 401(k), no ability to take loans, and a higher penalty of 25% if funds are taken out prior to age 59 ½ in the first two years of participation in the plan. Employee contributions are pre-tax and employer contributions are deductible.

2. SEP IRA

The Simplified Employee Pension is particularly well-suited for sole proprietors, and for businesses with few employees. It can create a meaningful tax benefit without a lot of administrative headache, because you can contribute a set percentage of up to 25% of your income to the plan.

Even though businesses that use the SEP IRA may exclude employees who are under 21 or have worked less than three out of the last five years, if you do have eligible employees, they all must receive the same salary percentage contributed to the plan by the business. It’s important to keep in mind that some business owners may not be in a financial position to make the same percentage level contributions to their employees as they want to make for themselves.

3. One-Participant 401(k)

Also known as a Solo 401(k), this plan can also be an excellent savings tool for sole proprietors. It’s similar to a SEP IRA, but there are significant differences between the two types of plans.

As one key difference, in a One-Participant 401(k), you can contribute and defer tax on up to $61,000 per year, combined between W-2 salary deferral contributions and end of year “profit sharing” contributions. In contrast, SEP IRA contributions are made entirely as employer contributions based on a percentage of net income, and the SEP does not allow for W-2 salary deferral. While the same $61,000 limit applies with the SEP IRA, many business owners may find it harder to reach that level of contribution each year because of the way the contribution amount is calculated.

As another key difference, the Solo 401(k) can also be designed to include a Roth portion, whereas the SEP cannot.

4. Personal Retirement Accounts

IRAs, Roth IRAs, and even taxable brokerage accounts are all suitable options for small business owners as account types to consider to save for retirement.

It’s important to know that you can have both company and personal retirement savings vehicles, but verify exactly which types of accounts you are eligible to fund depending on your income level, and which type of workplace retirement plan you may have.

For many business owners, it may make sense to max out your company plan first to take advantage of the potential tax benefits. If you do already have a plan through your business, it usually means you won't be able to make a deductible traditional IRA contribution. However, don’t let that stand in your way. Make a non-deductible or Roth contribution. Don’t let the vehicle be a barrier to saving for retirement.

How To Decide Which Plan Is Best For Your Small Business

The kind of retirement savings plan that’s best for you depends entirely on your financial situation and objectives, which are different for every small business owner.

As part of the decision making process, consider how many staff members you have, how many hours they work, and your priorities. Is the plan a necessity to increase your company’s retention and productivity, or is it more important to make the plan work for you as the owner?

In addition, weigh the pros and cons of the various options. For example, you have a lot of flexibility with a 401(k) and you can make changes to the plan in the future, whereas you’re limited in this area with a SIMPLE or SEP IRA.

Trusted Financial Advice For Small Business Owners

Regardless of what direction you choose to take with your company’s savings and retirement plan, it’s critical to get an outside perspective on your finances as a small business owner.

There are numerous elements of plan design to consider, which is why it’s essential to discuss your options with a professional who understands the rules associated with each plan and how they align with your objectives—or not.

You also need someone knowledgeable about the tax element of financial planning for small business owners, an area that requires additional expertise.

At Bay Point Wealth, we have serious tax chops. We also have access to a network of trusted experts who can help craft the perfect savings and retirement plan for your company. If you’re a small business owner who needs guidance in this area, schedule a call with us today—we’d love to help.

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Topics: Financial Planning, Retirement Planning, Business Owner News