Planning for retirement should be an essential part of any entrepreneur’s long-term financial strategy. However, many entrepreneurs fail to plan effectively. This can lead to missing out on tax breaks as well as issues with retirement security later on in life.
There is a range of ways you can maximize your retirement savings by taking advantage of some of the common plans available to entrepreneurs in the US.
In this guide, we’ll take a look at the importance of retirement planning and the types of plans that could be available to you as you grow your business Stateside.
On This Page
- Why Entrepreneurs Fail to Plan
- Individual Retirement Accounts
- Traditional IRA
- Roth IRA
- SEP IRA
- Solo 401(K)
- Cash Balance Plans
- Selling Your Business When You Retire
- International Retirement Income
- Need Support to Develop Your Retirement Plan? Get in Touch Today!
- Frequently asked questions (FAQs) about taxes, company formaition, and residency in the U.S.
- Get advice on taxation, company formation, and residency in the U.S.
Over a third of entrepreneurs doing business in the US have no current retirement savings plan in place. This is despite over 60% of business owners saying they want to retire before they reach the age of 65.
There are a variety of reasons why entrepreneurs may decide not to plan for retirement, including:
- They focus on putting all the spare profit they make back into the business. This is understandable, especially in the early days when every cent counts, but as time progresses it can lead to a serious lack of funds put by for later years.
- Viewing the business itself as the retirement plan. Lots of entrepreneurs visualize selling their business at the end of their working life and using the money to retire on. This can backfire if the business fails to sell, or if the entrepreneur overestimates the future value of the business.
- Lack of time and resources to plan effectively. Many busy business owners simply don’t place retirement planning high on the “to-do” list. Some see it as something they can figure out at a later date, while others are unsure about how to invest or how to get started.
In addition to the potential reasons for not planning for retirement above, many entrepreneurs also think that they will continue to work well past the age of retirement so don’t see a need to plan.
While this may seem attractive in many ways, it doesn’t take into account the possibility of ill-health, a change of circumstances or the chance that in the future this mindset might be different.
An effective retirement plan can guard against potential issues later in your life, but also help you to take advantage of tax breaks as you set aside money. Careful planning can help to protect you and your family further down the line and ought to be a top priority for all forward-thinking entrepreneurs.
So, how do you decide how much you need to save and what the best retirement plan is for you?
Let’s take a closer look at some of the main options available to you Stateside.
Individual Retirement Plans (IRA’s) are savings accounts designed to assist individuals to save for retirement. Because they are not associated with an individual employer, you can use them regardless of whether you are employed or self-employed – which makes them a popular option for entrepreneurs. IRA’s tend to be easy to set up and they have the advantage that you don’t pay tax on dividends or capital gains from investments.
There are three main types of IRA that could be of benefit to you as an entrepreneur: a Traditional IRA, a Roth IRA or a SEP-IRA. Each plan has different advantages and limitations based on your income and your preference about how you want to manage your tax burden each year.
IRA’s typically have a relatively low limit on contributions you can make each year – in 2019 you could contribute $6000 if you are 50 or under, and $7,000 if you are 50 or older. However, for both of these options, there are differences in the way you are taxed and the income thresholds for qualifying.
A Traditional IRA is the most common type of IRA. With a Traditional IRA, you gain the ability to contribute pre-tax money and have that reduce your taxable income each year.
The tax deduction for a Traditional IRA depends on your individual or joint income if you are married and filing jointly.
During 2018, you could deduct the full amount you contribute if your income was less than $63,000 as an individual, and less than $101,000 if filing jointly (as part of a married couple).
If your income is higher than this, then you can deduct a partial amount (for incomes up to $73,000 as an individual and $123,000 if filing jointly). If your income goes above these thresholds there is no opportunity for a tax deduction on your income either as an individual or filing jointly.
The main benefit of choosing a Traditional IRA is that your tax deductions occur in-year as you save – which means you get the immediate tax break each year. However, there are some disadvantages to a Traditional IRA.
Generally speaking, a Traditional IRA comes with early withdrawal penalties of around 10%, as well as the requirement to pay tax on any withdrawals. The age limit for contributing to a Traditional IRA is 71.5, past this age you are no longer allowed to contribute. You must also begin taking out Minimum Required Distributions at the age of 71.5.
Overall, the Traditional IRA can be advantageous tax-wise if you have the discipline to save and invest the tax break you get each year.
A Roth IRA has very similar features to a Traditional IRA. The amount you can contribute each year is the same, however, you pay tax on your contributions each year. This means that when you retire there are no taxes to pay.
To be eligible for a Roth IRA you must have an income of under $203,000 if filing jointly or $137,000 if filing as an individual, Head of Household or filing separately from your spouse.
The early withdrawal rules for a Roth IRA are more flexible – you can withdraw contributions at any time without a penalty or paying tax on the withdrawal. There are also no limits on the age you must be before you can start making withdrawals, and you can leave the money in your Roth IRA account for as long as you like.
This can be an advantage if you are planning to use your Roth IRA to help build money in your estate for your heirs, as you can continue to contribute to the plan past the age of 71.5.
A Roth IRA makes sense for long-term tax planning as you have to put the money for tax into the account as you go. This prevents that money from being spent in-year.
A Simplified Employee Pension (SEP-IRA) is an IRA specifically designed for small-business owners and those who are self-employed. This plan enables you to contribute money for retirement into an account as well as contributing to retirement accounts for employees.
This plan works well if you have employees who work over 1,000 hours per year. You must contribute an equal amount to your employee’s accounts as you do to your own. So for example, if you contribute 10% to your plan, you also contribute 10% of their salary to each employee’s plan. Using a SEP IRA enables you to defer income tax on up to 25% of compensation up to $280,000 for a maximum contribution of $56,000.
A SEP IRA can be a great way to take advantage of tax breaks as your contributions are tax-deductible as a business expense. You are not required to contribute to a SEP IRA for you or your employees each year. This means you can be flexible about payments depending on how well your business is doing each year.
The limits on withdrawing money on a SEP IRA are very similar to a Traditional IRA. You cannot withdraw money before the age of 59.5 without an early withdrawal penalty of 10% and by the age of 70.5, you must start taking Required Minimum Distributions.
A Solo 401(K) plan is for individual participants that cover you and your spouse if you have no employees. You can make contributions to a Solo 401(K) as both an employer and an employee. You may be eligible for a Solo 401(K) if you employ seasonal workers who work under 1,000 hours per year.
As of 2019, a Solo 401(K) allows you to defer paying income tax on contributions up to $19,000 as an employee if you are under 50, and $25,000 if you are over 50. As an employer, you can also add up to 25% of your compensation or net self-employed income. If your business acquires more than $250,000 in assets you will need to file an annual report.
You may add your spouse to your 401(K) but they have to be earning an income from your business to be eligible. There are no upper limits on your income to qualify for a Solo 401(K).
You can also add Roth contributions from employee contributions (so up to $6000 pre-tax contributions). Being able to contribute both as an employer and employee make this option very attractive to many entrepreneurs.
A Solo 401(k) can be advantageous tax-wise because you are allowed to choose the best tax advantage for you. It may also offer better protection from bankruptcy as the assets in your 401 are protected from creditors for as long as they remain in the 401 plan.
Cash Balance plans combine features of 401(k) plans and traditional pension plans. These plans are defined as benefit plans (as opposed to contribution plans such as a 401(k)). The plan specifies how much you will receive when you retire.
Cash Balance plans are particularly useful if you are older and looking to bolster your retirement savings quickly. Because the plan specifies how much you will receive in retirement (with an annual upper limit of $216,000), then in-year contributions can be as high as you need them to be to fund the agreed on benefit. This means you can make sizeable contributions for employees who are older and approaching retirement and smaller contributions for those who are younger or are lower-paid.
A disadvantage to a Cash Balance plan is you have to meet your funding commitments each year – you can’t defer payment if your business has a more difficult year. However, you can take your benefit as a lump sum or an annuity to be paid each year once you retire.
You may decide that selling your business is where you would like to focus a good deal of your retirement planning. If you decide to take this route, then you need to plan to sell your business in a way that is tax efficient.
It’s important that you do full research on your options because the tax you end up paying could be as high as 50% or even more or the sale price of your business. Selling business assets is likely to result in Capital Gains tax. Capital gains can also vary from state to state so make sure you do your research and are aware of the rates for the state you plan to relocate to.
One of the best ways to avoid paying hefty capital gains tax is to take advantage of the Roth IRA or a 401(k). These plans will allow you to make contributions and only pay income tax on withdrawals. Gains are also not taxed while they are in the account. You can also consider gifting assets to family members in order to avoid capital gains tax. You can gift $14,000 as an individual or $28,000 tax-free if filing jointly to a family member who is in a lower tax bracket – if the amount does not put them into a higher tax bracket they will not need to pay capital gains if they sell the assets.
Because you’ve probably spent a good deal of your working life in Europe it’s very likely that you will have some retirement income from sources based in Europe, as well as America.
You might, for example, have a state pension, or investment property. There will be different rules regarding the tax you pay on these sources, depending which country you previously resided in and if there are agreements in place between the US and that country on issues such as double taxation.
Generally speaking, your residence at retirement will determine which country taxes you on your income and you will need to declare income from any source outside of the US. For foreign pension schemes, this can impact the tax savings potentially available to you. For example, in the US you can use one of the retirement plans mentioned above to get tax breaks on your contributions either as you pay, or when you retire. However, contributions from a UK pension scheme may be immediately taxable on your US Tax Return.
Because the rules can be complex and will vary depending on the type of international savings you have, the country you lived in before you moved to the US, and what sort of agreements are in place between different countries, it’s extremely important that you get expert tax support to help you develop a comprehensive plan that accounts for your unique situation.
Retirement planning is a vital part of a healthy long-term financial plan. Smart entrepreneurs ensure that they take the time to put a plan in place and regularly review it to make any adjustments needed. But, it can be a complex process, as you can see from this guide.
The good news is that with careful planning and sound decision-making you could potentially save a huge amount of money on taxes and be confident that you and your family’s future is secure.
If you are thinking of setting up a retirement plan, or you want some support with an existing process then Mount Bonnell Advisors can help. We work in partnership with a range of skilled tax professionals who work Stateside and have experience supporting European business owners with international retirement planning.
Get in touch today to find out how we can support you with advice on Retirement Planning.
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