Retirement Planning Overview: For Business Owners

Retirement planning is a crucial yet often overlooked component of business ownership. Unlike traditional employees, business owners must take the initiative to establish and manage their own savings for the future. A carefully selected and well-structured retirement plan helps provide financial security in later years and provides immediate advantages, such as tax benefits and increased business stability. Additionally, offering retirement benefits can enhance employee satisfaction and retention, strengthening the overall success of the business. This paper will seek to outline some of the benefits of retirement planning, clarify some of the complexities in retirement planning, and provide an overview of the various types of plan options available that may suit the needs of business owners.

Benefits of Retirement Planning

Retirement planning offers several benefits for business owners, helping them secure their future while also providing advantages for their company. Four of these benefits are first, it allows for significant tax savings by deferring income into retirement accounts, reducing taxable income for both the business and the owner. Second, it may provide a tax credit in the year the plan starts. Third, a well-structured retirement plan can improve employee retention and satisfaction, making the business more attractive to top talent. Lastly, it can help provide financial security for the business owner by building a pool of assets that is specifically set aside for funding their lifestyle in retirement.

Complexity of Retirement Plans

The first challenge business owners face is selecting the right type of retirement plan to implement. During this process, specific terminology is used to highlight the differences between various plans. Two of the most important distinctions include Qualified vs. Non-Qualified Plans and Pension Plans vs. Profit-Sharing Plans.

Qualified vs. Non-Qualified Plans

A Qualified Plan is generally a plan that meets the minimum standards established by the IRS and the Employee Retirement Income Security Act (ERISA) to be considered Qualified. This paper provides a brief overview and does not cover the extensive list of IRS and ERISA requirements to make a plan “Qualified”. It is worth noting, however, that while establishing a Qualified Plan has strict rules, these plans provide protections that are not always available in other plans. These include creditor protection, prohibitions on certain transactions, and disclosure of plan information. There are additional Qualified Plans that are simpler to open and operate, and offer similar protection, but do not have to meet all requirements of ERISA. A few of the most common Qualified Plans include the following:

A Non-Qualified Plan allows for some, but not all the tax advantages in a Qualified Plan. It does not have to meet ERISA standards and does not have to be available to all employees. A Non-Qualified Plan is best suited for employers who want to offer additional incentives to attract and retain key employees and executives. The tax advantages vary from plan to plan and are extremely nuanced. There is generally no limit to how much may be saved into these plans. The key with these plans is that they are an “unfunded promise to pay”, meaning a specific account for each employee is not established. There is simply a promise to pay some benefit in the future. The most common form of this plan is a Deferred Compensation Plan.

Pension Plans vs. Profit-Sharing Plans

Both a Pension Plan and a Profit-Sharing Plan fall under the category of a Qualified Plan. There are four distinct types of Pension Plans. A Pension Plan’s key feature is that a legal promise is made to pay some form of a pension at retirement. These plans have become less popular over the years. As companies have increased in size and have had a larger and larger group of people they are obligated to pay in retirement, while also being responsible for the investment risk, it has become unattractive for business owners to assume this responsibility. A Pension Plan may still be a great option for business owners who have a very reliable and steady source of revenue and want to provide this benefit to their employees.

There are seven types of Profit-Sharing Plans. Unlike a Pension Plan, there are no mandatory funding standards, nor a promise to pay a pension at retirement. Rather, a Profit-Sharing Plan is established to defer compensation and taxation for both the employer and employee while the employee works at the company. There are many variations in how funds can be contributed. Generally, an employer will contribute either cash or shares of company stock into the plan based on a pre-determined formula, and the employee may elect to defer a portion of their compensation into the plan. The amount of funds contributed from both the employer and employee are deducted from their taxable income, and the assets grow tax deferred.

1

Plan Options

One of the top tax policy goals of President Trump is extending and expanding the TCJA. For the reasons discussed above and the estimated $4+ trillion increase to the deficit, a complete extension of the TCJA is unlikely to occur. Republicans have three primary means to reduce a bill’s deficit impact and make it easier to pass: (i) make any cuts shorter, (ii) make the bill skinnier by reducing the tax cuts, and (iii) include pay-fors. Of these options, pundits feel that curtailing the duration and including pay-fors are the most likely approaches to be taken.

Considering potential plans based on company size can be useful when selecting a retirement plan. The size of the company may have 0 employees (not including a spouse), 1-10 employees, and more than 10 employees. This is a generalization, and a specific plan that is listed under one size of a company may still be a good fit in another category.

0 Employees (not including a spouse)

Individual 401(k)

An Individual 401(k), also referred to as a Solo(k), is simply a 401(k) Plan with only the employer and his/her spouse as the only other employee. This is a Qualified Plan but does not have to meet ERISA standards since the plan does not cover any other employees. This plan is easy to set up and operate. A common practice with these plans is to max out the “employee” contributions, which is $23,500 in 2025, and then once the accounting is complete for the business at year-end, determine if and how much a profit-share contribution from the “employer” may be prudent. Because a plan may also be established for the business owner’s spouse, the couple has the potential to contribute, and thereby defer, up to $140,000 of taxable income in the year 2025.

1-10 Employees

SEP IRA

While a SEP IRA may be used for businesses of any size, it is commonly used for companies with fewer employees. Contributions into a SEP IRA will be made exclusively by the employer. Some SEP IRAs have the option to also act as a Traditional IRA that employees may make standard IRA contributions into, but this does not count towards the SEP contributions from the employer. Each year the employer may decide to contribute up to 25% (up to $70,000 in 2025) of the compensation of each employee. Whatever percentage is chosen will be the same for every employee and the employer. This percentage may change each year, allowing for flexibility based on business circumstances. These plans are commonly used when business owners want to make 100% of the contributions and desire some flexibility in when and how much to contribute.

SIMPLE IRA

Unlike a SEP IRA, contributions into a SIMPLE IRA are initiated by the employee. In 2025, an employee may elect to defer up to $16,500 of their compensation into this plan. The employer must match up to 3% of the employee’s compensation. If an employee does not make an election to save into their plan the employer does not have to contribute. Another option the employer has is rather than matching contributions up to 3%, they can make nonelective contributions at a flat 2% of compensation, which must be made regardless of whether the employee contributes or not. SIMPLE IRAs are also best suited for employers who want flexibility, but do not want to make 100% of the contributions into each employee’s plan.

Profit-Sharing Plan

In a Profit-Sharing Plan, employers may elect to contribute a portion of company profits to employees. This can be highly motivating for employees as they will now have a vested interest in increasing the profits of the business. Whether to make a profit-sharing contribution each year is at the discretion of the employer. If the employer decides to make this contribution then it must be done using a pre-determined formula. If paired with a 401(k) plan, which will be discussed below, the total amount of contributions may not exceed $70,000 in 2025. If a profit-sharing contribution is made, the business may deduct up to 25% of the compensation paid to participants. These plans allow flexibility based on business circumstances, offer additional incentives to employees, and provide significant tax advantages.

More than 10 Employees

401(k) Plan

A 401(k) Plan is the most utilized retirement plan option. According to the Investment Company Institute², at the end of the third quarter in 2024 there was an estimated $8.9 trillion in 401(k) assets. In a 401(k), an employee can choose to save a portion of their compensation up to $23,500 in 2025, and depending on how the plan was set up, the employer contributes or matches up to a certain amount. These are Qualified Plans that are subject to ERISA. As such, they are required to go through strict testing to ensure they are fair to all employees. To manage some of the complexity of these plans an employer may use a Third-Party Administrator (TPA) to help ensure compliance with the various rules and regulations. A 401(k) plan may be used for a business of any size, but because they have less flexibility and stricter rules in setting up and operating the plan, they are often used in slightly larger companies.

Stock Bonus Plans

The Profit-Sharing Plan mentioned above is a viable option if the company has cash resources available to make additional contributions to the plan. A Stock Bonus Plan may be thought of as a Profit-Sharing Plan, where company stock is made as a profit-share contribution rather than cash. A Stock Bonus Plan is a Qualified Plan and must meet ERISA and IRS requirements. These Plans include deferral of income taxation until stock, cash, or some other asset is ultimately distributed from the plan. The deductibility of contributions into these plans is also limited to a maximum of 25% of an employee’s compensation. An additional benefit is that contributions are made on a discretionary basis. This gives employers the flexibility to make, or not make, contributions each year depending on the needs of the business. When contributions are made every eligible employee must be included. However, the company does not need to have a profit to contribute to a Stock Bonus Plan, offering even more flexibility.

Deferred Compensation Plan

A Deferred Compensation Plan is not a Qualified Plan, which limits some of the protection and benefits, but allows for other benefits not available in a Qualified Plan. Deferred Compensation Plans can be implemented for only select key employees and executives with no limit to the amount that may be contributed, and if specific rules are followed, they offer some tax advantages. Typically, when these plans are used, they are for employees who are already in a higher marginal tax bracket and do not need additional funds to pay their living expenses. The employee would elect to defer a portion of their compensation to some future event, such as retirement. These plans come in many forms including an unfunded promise to pay, several types of Trusts, insurance policies, phantom stock plans, supplemental executive retirement plans, salary-reduction plans, or 401(k) wrap plans. In all these variations, a portion of compensation will not be made available until a future date. This allows the employee to defer taxation to a later date. For the employer, they will not receive a tax deduction until the funds are ultimately distributed, made available, or set aside for the employee at that future event. These plans are excellent for larger companies who want to retain key employees or executives and will have sufficient assets available to make the payments in the future.

Defined Benefit Pension Plan

While pensions have lost popularity over the years, they still may be an attractive option for a company’s retirement plan. There are a few different versions of a pension plan. While the details may vary, the goal of a pension plan is either to provide for a fixed income stream or a specified lump sum amount at retirement. Part of why these plans have lost popularity is that the investment risk is assumed by the employer. The employer is responsible for ensuring that funds set aside for an employee’s pension are sufficient to pay the promised fixed income or lump sum. Whereas in a 401(k), the employee is responsible for selecting which funds to invest their money in and the plan does not have a promise to pay a specific amount in the future. Companies that typically utilize a Pension Plan are companies with reliable and steady revenue that can support the future payments to be made. Having a Pension Plan can be highly motivating for employees to remain with a company so they can have an increased sense of confidence in retiring with a reliable income source.

Conclusion

Selecting a retirement plan for a business is an important part of preparing for the future. Talking through the available options with financial, tax and legal professionals is advisable to ensure all rules and regulations are accurately followed and to help both employers and employees prepare for a successful retirement. A well-structured retirement plan can also enhance employee satisfaction and retention, contributing to the long-term success of the business. Taking the time to choose the right plan now can provide financial security and peace of mind for years to come.

References

1 – James F. Dalton & Michael A. Dalton. (2021). Retirement Planning and Employee Benefits. Metairie: Money Education.

2 – Investment Company Institute. (2024, December 19). The Asset Management Industry SERVING INDIVIDUAL INVESTORS. Retrieved from The Investment Company Institute: https://www.ici.org/print/pdf/node/836811