Basic Retirement Planning

By Jason Watson, CPA
Posted Saturday, September 28, 2024

Most people have a pretty good handle on personal finance and basic retirement savings, and while the principles are generally the same in the small business world, a lot of business owners have a deer caught in your headlights at 2:00AM look when it comes to leveraging their business for retirement. And there is good reason- retirement planning within your small business carries a bunch more options and potential pitfalls (sounds like life in general, doesn’t it?).

Reasons for Small Business Financial Planning

There are three major wealth considerations for small business owners (or anyone for that matter)-

• Accumulation (fun and exciting part)

• Preservation (the tricky part)

• Transfer (the necessary evil part)

Each of these major wealth considerations are interwoven, needs comprehensive focus to ensure the necessary dots are connected, and should have no gaps or holes exist during transitions. That is where financial planning comes into play.

Accumulation is easy. Most people think if they toss some money at a mutual fund they are planning for retirement. Nope.

Preservation gets tricky since we need to have our money outlast our lives. And with people living well into their 90s, this can be tough. Let’s put it another way- if you work for 40 years, from age 25 to 65, you need to save enough to live for another 25-30 years. That is incredible. If you are spending $100,000 at age 55, you better be making $180,000 and putting the $80,000 into a moderate growth retirement vehicle.

Preservation also includes proper insurance, asset protection through trusts, pro-active maneuvering and other tools in the toolbox.

Transfer of wealth is automatic. We have yet to see a hearse with a trailer hitch. Or, said in a completely starker way, every life comes with a death sentence. How it is executed is partially up to you. Did we just ruin your appetite? Sorry.

Transfer of wealth can also be tricky. The current federal estate tax exemption is $12.92 million (for the 2023 tax year) per person, and a passed spouse can posthumously port his or her exemption to the surviving spouse. Not bad. And most people don’t have over $26 million in estate value. Rich people problems (now referred to as high net worth… the most over-used and water-downed phrase today).

Sidebar: According to a November 2019 Forbes article, over $30 trillion in wealth will be transferred by baby boomers. Furthermore, according to a 2018 study from Bankrate.com, millennials are less inclined to invest in the stock market. So, where this wealth goes is certainly unclear.

These federal exemption amounts are indexed each year, and while Congress can always vote to repeal, this estate tax exemption was written in stone with passing of the American Taxpayer Relief Act of 2012. However, various states have much lower exemptions. For the 2022 tax year, Connecticut was $9.1 million, Hawaii was $5.5 million, among other examples.

Nebraska does not have an estate tax, but they do have an inheritance tax (the recipient pays depending on relationship and could be as high as 13%). California, the class favorite, is one of 33 states that do not impose an inheritance tax. Apparently, you’ve been taxed to death and there is nothing left to tax when you die in California.

Therefore, just because you are out of woods federally, doesn’t mean the transfer your wealth is free of taxation. Get a plan.

What about your business? Does it have an exit strategy or wealth transfer strategy? Businesses are like marriages; easy to get into, hard to get out. Add this to the plan.

The reasons for financial planning are-

Goals and Objectives

Define your goals and objectives, determine your current position and discover unmanaged risks. This sounds simple and makes sense, but defining goals and objectives is a fluid concept. They change. And as they change, the plan needs to be malleable enough to adapt. Financial plans are modified annually or whenever a major life change as occurred, whichever is more frequent. This is important.

The Plan

Financial plans also create a blueprint and chart a course on how to reach goals and objectives while managing risk. Again, this sounds simple. But even the most basic house needs a blueprint for framers, plumbers, electricians and even inspectors to review and implement. And in the case of a financial plan, these same players are your financial advisors, tax professionals, attorneys and insurance specialists.

Accountability

Financial plans also provide confidence, measure success and hold everyone accountable. If everyone agrees that your financial plan will ensure financial security in your life, then it becomes a measuring stick for determining success along the way. Anyone can throw some money at an investment, but what does it mean? And does it fit the plan? And is the selection of that investment meeting the plan’s objectives.

WCG CPAs & Advisors can always assist you with retirement and financial planning as it relates to your small business and taxation. If you need a referral for a financial advisor, we might be able to help with that too. However, we have fallen out of favor with a lot of the assets under management fee schedules, so we have trouble endorsing an advisor since most charge a percentage based on your asset values. We are not quite sure how the size of your portfolio translates into time and expertise, and in turn the value for services provided, but we digress.

Small Business Retirement Plans Comparison

We are going to put the carriage in front of the horse, and show you a comparison of basic small business retirement plans before explaining each plan. We cheated, and used Pacific Life’s online calculator to demonstrate these differences. Why re-invent the wheel? And frankly, they do a fantastic job at this type of stuff. Here is their link-

wcginc.com/6103

We took a handful of salaries (for corporations including S corporations) and net incomes (for sole proprietors and partners in partnerships) and plugged them into Pacific Life’s calculator, and came up with the following table based on the 2023 tax year limits-

Salary/Income	Entity	Max 401k	Max SEP IRA	Max SIMPLE
60,000	Sole Prop / Partner	33,652	11,152	17,162
60,000	Corporation	37,500	15,000	17,300
125,000	Sole Prop / Partner	45,734	23,234	18,963
125,000	Corporation	53,750	31,250	19,250
150,000	Sole Prop / Partner	50,381	27,881	19,656
150,000	Corporation	60,000	37,500	20,000
174,000	Sole Prop / Partner	54,848	32,348	20,321
174,000	Corporation	66,000	43,500	20,720
232,000	Sole Prop / Partner	66,000	43,792	21,928
232,000	Corporation	66,000	58,000	22,460
264,000	Sole Prop / Partner	66,000	50,106	22,814
264,000	Corporation	66,000	66,000	23,420
346,000	Sole Prop / Partner	66,000	66,000	25,086
346,000	Corporation	66,000	66,000	25,400

Note the bolded $66,000 number. This is the maximum defined contribution amount permitted in 2023 per plan (and Yes, you can have two plans- we’ll talk about Greg and his two plans in an example later).

Crazy! The following are some quick observations-

• In 2023, the maximum you can contribute to a qualified retirement plan is $66,000 ($69,000 for the 2024 tax year). You can go above this with a defined benefits pension (cash balance)- more on that later.

• Partnerships (those required to file Form 1065) follow the same limits as Sole Prop above.

• $174,000 in W-2 salary from your C Corp or S Corp is the magic number for maximizing your 401k. After that, any increase in salary does not help. Your fastest way to reach your contribution limit is through a 401k plan.

• $264,000 in W-2 income from your S Corp is the minimum salary for a max SEP IRA contribution.

• $346,000 from your small business or K-1 partnership income from your Schedule E as reported on your individual tax return is the magic number for maximizing your SEP IRA contribution. SEPs are old school and used for crisis management rather than planning (more on that too).

• Earned income from a sole proprietor is net profit minus 50% of your self-employment (SE) tax minus your contribution. Since the contribution actually adjusts the maximum contribution, this can be a circular reference. And No, 401k or SEP contributions do not reduce SE tax.

• 401k max is computed by taking $22,500 employee (you) contribution, plus 25% of your W-2 or earned income (as adjusted). The $22,500 goes to $23,000 for the 2024 tax year.

• SEP IRA max is computed by taking 25% of your W-2 or earned income (as adjusted).

• Max SIMPLE 401k is basically $15,500 plus 3% of your W-2 or earned income (as adjusted). Don’t spend too much time thinking about SIMPLE 401k plans. This increases to $16,000 for the 2024 tax year.

• You can add $7,500 for catch-up contributions if you are 50 years old or older.

Let’s talk about each of these qualified plans in turn, starting with the 401k. Out of the box, or non-traditional retirement plans will follow (profit sharing plans, defined benefits pensions, cash balance plans, Section 79 plans, etc.). Exciting!