Creating your retirement plan as a small business owner
The road to retirement has always been the same: work, save money, then retire. Once you have retired, you can take exotic vacations, spend more time with friends and family, or start a new hobby. But you also have to sustain your daily expenses without relying on a regular paycheck. In order to do that, you need a good retirement plan.
One thing that has changed over the years is life expectancy. Life expectancy is now longer, and your money may have to last into your 90s. If you had the benefit of working for a company with a pension, you might be guaranteed a certain amount of money when you retire. More and more companies are moving away from pensions, though, and as a small business owner, you may not even have the luxury of matching contributions to your 401(k).
Whether you own a small business or not, it’s crucial that you start planning for your retirement now. Retirement planning is the process of setting goals for your retirement and determining the actions you need to achieve those goals.
Today, we’ll share everything you need to know about creating your retirement plan.
Why do you need to create a retirement plan?
It can be easy to cover your expenses when you’re earning a regular income. After you retire, though, you’ll still need enough money to continue paying your expenses and enjoying your life.
Here are a few reasons you need to plan for retirement.
To cover daily expenses
Even after retiring, you still have to pay for housing, utilities, food, and transportation. By planning for your retirement now, you can ensure that you can cover your daily expenses and have enough left to live your life.
To cover medical expenses
The older you get, the more health issues and emergencies you tend to have. And medical expenses can cost a lot of money because Medicare might not cover everything. Your savings need to be able to pay for any medical expenses you’ll face during retirement.
To fight inflation
Inflation is the rise in goods and services, which decreases the value of your money. Because of near-constant inflation, you can expect to pay more for everything during retirement. By creating a retirement plan now, you can ensure you have enough to afford everything you need.
To deal with uncertainties
Life is unpredictable, and you never know when you’ll encounter a situation that creates financial or emotional turmoil, such as a natural disaster or losing a loved one. If you start planning for your retirement now, you can ensure you have enough money to handle any emergency you might face.
Benefits of creating a retirement plan now
While planning for your retirement can ensure you have the funds you need to live comfortably after you stop working, creating a retirement plan can also benefit you now.
- Planning for retirement can help you understand how quickly you can achieve your retirement goals.
- With a solid retirement plan, you’ll gain better control over your cash flow and understand what level of risk you need to take to retire when you want.
- A retirement plan can help you define a path for achieving all your life goals.
Steps for creating your retirement plan
Retirement planning does not have to be complicated. There are several steps you can take to create a road map that will keep you on track and help you retire when you want.
1. Set your retirement goals
Before you retire, decide what you want life to look like in your 70s or 80s. Write down what you want to accomplish during your retirement years, whether it be taking up a social cause, staying home and relaxing, starting a new business, traveling, or spending more time with your family. By defining what you want retirement to look like, you will not be overwhelmed by the idea of saving for an unknown future. Instead, you’ll understand exactly why you’re setting up a refund fund.
2. Decide your retirement age
When you retire is usually a matter of choice. You might want to retire in your 60s (or earlier), or you might want to work into your 70s. No matter when you want to stop working, estimating your retirement age is essential because it will help you determine how much you need to save. The current life expectancy in the United States is roughly 76 years. So if you plan to retire at 60, you’ll need to ensure you have enough saved for 16 years of post-retirement life.
3. Identify income sources
Once you’ve decided on your retirement goals and age, it’s time to start calculating how much you need to save. The first step in that process is to add up all the income you might receive during retirement. This income might include the following:
- Pension income
- Social Security payments
- Retirement fund disbursements
- Rental income
- Profits from the sale of your business
4. Determine retirement expenses
Next, you’ll need to list your retirement expenses. While you will not know exactly how much everything will cost in the future, you can expect that many of your expenses, like groceries, will be higher due to inflation.
Start by writing down your current monthly expenses to create an accurate depiction of what you need to maintain your current lifestyle after retirement. But remember that you may not have some of those expenses (like a mortgage or childcare) in the future.
Some of the expenses to include are
- Housing costs, like rent or mortgage and home maintenance
- Utilities, such as gas, electric, water, and internet
- Healthcare costs
- Day-to-day living costs, like food, clothing, and transportation
- Entertainment, such as restaurants and movies
- Travel, including flights and hotels
5. Calculate your retirement savings needs
Many experts state that you need between 70 and 90 percent of your annual income for retirement. That means if you’re earning $100,000 per year before retirement, you will need between $70,000 and $90,000 per year during your retirement years.
Of course, this is just a guide, and your situation will be unique. Because you have identified your income sources and estimated expenses, you can better calculate how much you’ll need during retirement. Match your income to expenses to determine if you have enough to retire and achieve your goals. If you don’t currently have enough, you’ll know how much more you’ll need to save before you can comfortably retire.
6. Choose the best retirement account for you
A cornerstone of your retirement plan is deciding where to save your money. There are many different types of retirement accounts that allow you to invest in a mix of stocks, bonds, and mutual funds. The right combination of investments will depend on how long until you retire. Generally, you want to invest aggressively when you’re young and slowly transition to a more conservative investment mix as you get closer to retiring.
But how do you know which retirement account type is right for you? If you have a 401(k) with employer matching, you likely want to start there. But if that’s not an option, which is common for small business owners, you can open your own retirement account, such as an individual retirement arrangement (IRA). There’s no single “best” retirement fund, but here are a few types to consider to help you find the right one for you.
1. SEP-IRA
A simplified employee pension, or SEP-IRA, is one of the easiest retirement accounts for small business owners to open and maintain (with minimal paperwork requirements), and it’s ideal for sole proprietors. Contributions to your SEP-IRA can be as high as 25 percent of your compensation or $66,000, whichever is less.
Unlike many other retirement accounts, contributions to a SEP-IRA are made by the employer, not the employee. If your small business employs workers, you’ll be required to contribute the same percentage of an employee’s compensation as you contribute to your own retirement fund.
2. Individual 401(k)
An individual 401(K) is only a retirement option if you work for yourself and your only employee is your spouse. It requires a little more administrative work than a SEP-IRA but also allows for higher contributions.
With an individual 401(k), you’ll act as both employee and employer and can make contributions in both capacities. So you can contribute
- elective deferrals, up to the lesser of 100 percent of your compensation or $22,500 (or $30,000 if you are 50 or older), and
- employer nonelective contributions, up to 25 percent of your compensation.
The total allowable contribution amount is $66,000 per year (plus a “catch-up” amount of $7,500 if you’re 50 or older).
If your spouse works for your small business, they can contribute up to $22,500 in elective deferrals (or $30,000 if they are 50 or older). And you, as the employer, can match that amount up to 25 percent of your spouse’s compensation.
3. SIMPLE IRA
A savings incentive match for employees, or SIMPLE IRA, may be a good option if your small business has 100 or fewer employees.
With a SIMPLE IRA, employees can contribute to their retirement account through elective deferrals up to $15,500 (plus a $3,500 “catch-up” contribution if they’re 50 or older).
As the employer, you’re required to contribute to each employee’s SIMPLE IRA. You can match their contributions (up to three percent of the worker’s compensation) or contribute two percent of their compensation (even if the employee did not contribute to their retirement account).
As a small business owner, you can contribute to a SIMPLE IRA. But you cannot contribute as much as with a SEP-IRA or individual 401(k) because you will be subject to the same contribution limits as your employees.
4. Traditional IRA
With a traditional IRA, you can contribute a portion of your pre-tax compensation to a retirement account up to the contribution limit of $6,500 (or $7,500 if you’re 50 or older). Depending on your income level and filing status, these contributions may be tax deductible. A traditional IRA requires you to start taking minimum distributions (which are taxed) after you turn 72.
5. Roth IRA
Roth IRAs are similar to traditional IRAs and subject to the same contribution limits. Contributions, though, are made after taxes, and there are no minimum required distributions. Once you start receiving distributions from your Roth IRA, they will not be taxed.
6. 401(k)
Most companies can establish a 401(k), and employees can defer up to $22,500 (plus a $7,500 “catch-up” contribution if 50 or older) of their compensation each year. As the employer, you can add to each employee’s account through matching, profit-sharing, or other special types of contributions.
As a small business owner, a 401(k) may be a good option if you also work for another company that offers matching contributions.
7. Start saving as soon as possible
The earlier you start preparing for retirement, the better your chances of achieving all your goals because your savings will have time to grow. And with every dollar you save now, the more comfortable you’ll be as you approach your preferred retirement age. Ideally, you should try putting at least ten percent of your income toward retirement.
But remember that it’s never too late to start retirement planning, so don’t feel like you’ve missed your opportunity if you did not start saving in your 20s. This is especially true since most retirement funds allow you to make “catch-up” contributions after you turn 50.
Do you want to retire early?
As a small business owner, you may think retiring early is not an option. But by creating a solid retirement plan now, you can retire when you want. To learn more, read our article “Tips to retiring early.”