My wife started a business 10 years ago and contributed to a regular IRA in the beginning. Three years ago, she incorporated the company and they don't have a 401(k) yet. What's her best option for retirement savings right now?
This is an excellent question—and one that every small business owner should ask, whether or not the business is incorporated. That's because, although contributing to an IRA is definitely a good idea, small business owners have several other options that can significantly increase the amount that can be saved for retirement in a tax-effective way.
Here are some small business retirement plans for your wife to explore. They offer a simple way for business owners—either sole proprietors or employers with few employees—to increase retirement savings opportunities and enjoy certain tax advantages without the paperwork, cost, and administration required by a regular 401(k).
Incorporation isn't the key factor here, but specifics such as whether your wife has employees and, if so, how many, can make one plan better suited to her situation than another.
SEP-IRA: The easiest to set up and maintain, particularly suited to sole proprietors
A SEP-IRA (or a Simplified Employee Pension) can be a great choice for saving a lot and keeping paperwork to a minimum whether or not you have employees. It's easy to open and lets you make fairly high annual contributions. It also gives you the flexibility to vary contributions—or skip them entirely—according to your yearly business needs.
A SEP-IRA can be ideal for a sole proprietor. Annual contributions can be as high as 20% of net self-employment income for an owner, up to $52,000 in 2014. However, there are a few caveats if you have employees.
First, all contributions are made by the employer, not the employee. And, as an employer, you're required to contribute the same percentage of an employee's compensation as you contribute for yourself. That could end up being a hefty sum if you have more than a few employees.
Individual 401(k): Offers higher contribution limits if you have no employees except your spouse.
An Individual 401(k) or an Individual Roth 401(k) can be a great choice for contributing a lot, but it's only available if you work for yourself and your only employee is your spouse.
It requires more paperwork than a SEP, but allows even higher contributions—20% of net self-employment income for the business owner, plus an additional $17,500 in salary deferrals for 2014, with a maximum of $52,000 for this year. If you're 50 or older, you can contribute an additional $5,500, bringing the maximum to $57,500.
If your spouse is also an employee, he or she can also contribute up to $17,500 in salary deferrals (plus a catch-up contribution of $5,500 if age 50-plus). And you, as the employer, can match that contribution up to 25% of salary. That all adds up to quite a significant sum! Another possible plus is that you can borrow against your savings.
SIMPLE-IRA: Good if you have up to 100 employees and want them to contribute to their own retirement.
A SIMPLE-IRA (or Savings Incentive Match for Employees) is available to companies with 100 or fewer employees. With this plan, employees make their own retirement contributions—up to $12,000 for 2014, with a catch-up contribution of $2,500 for those age 50-plus. As the employer, you're only required to make a small matching contribution (1 to 3% of employee compensation).
While your obligation as an employer is less, the contributions you can make for yourself are also significantly lower than for a SEP-IRA or Individual 401(k). That's because the business owner is subject to the same contribution limits as employees.
A regular IRA: Still a smart personal choice
The good news is that you can contribute to both a small business retirement plan and a regular IRA and potentially get a tax deduction for each, depending on your income. So I encourage your wife—and you, too—to contribute the maximum to an IRA each year. For 2014, that's $5,500 with a $1,000 catch-up contribution if you're 50 or older.
The bottom line: Talk to your tax advisor
As you can see, there are a number of options for small businesses, depending on how many employees there are and the type of opportunity a business owner wants to provide for employees.
The next thing for your wife to do is to talk to her tax advisor—and also any business partners—to determine which plan offers the best combination of savings opportunities and tax advantages for her specific business. While all of these plans require minimal set-up and administration, the details vary. It's best to get all the facts—then weigh them in light of current business plans and future goals.