The right retirement strategy may help you keep more of the money you are already generating while lowering your tax bill.
Retirement Plans for
E-Commerce Entrepreneurs
What is your strategy for growing you net worth?
As your E-commerce business grows, it is important to have a strategy for keeping more of the revenue you are bringing in. A tax-advantaged retirement plan may allow you to reduce your tax bill, and keep more of your money for future use.
When you contribute to a retirement plan
- Your contributions are deductible
- Your contributions grow tax-deferred
- Your employee’s aren’t tax on contributions until they are distributed
Types of plans and disclaimers...
The IRS knows each business is different. They allow for several different times of retirement plans to fit the needs of individual companies. This can result in significant differences (pros and cons) to each type of plan. For example retirement plans are usually either IRA-based (think SEP’s and SIMPLE IRAs) or “qualified” (401k’s and such). A qualified plan is generally more expensive to maintain and complicated to run, but it may also allow for higher contributions. Some qualified plans also allow vesting periods, which may encourage employee retention, while with IRA-based plans your employees get full ownership of funds at the time of contributions.
Not every plan is right for every business. A plan should only be established following careful consideration of your business and after speaking with a tax advisor. Reading this article is not sufficient to make a decision, but it can be a good place to start.
SEPs
A SEP (Simplified Employee Pension) allows you to set up an IRA (a “SEP-IRA”) for yourself and each of your eligible employees. You contribute a uniform percentage of pay for each employee, although you don’t have to make contributions every year, offering you some flexibility when business conditions vary. For 2022, your contributions for each employee are limited to the lesser of 25% of pay or $61,000 (up from $58,000 in 2021). Most employers, including those who are self-employed, can establish a SEP.
SEPs have low start-up and operating costs and can be established using an easy two-page form. The plan must cover any employee aged 21 or older who has worked for you for three of the last five years and who earns $650 or more.
Pros and Cons
- Easy to set up and operate
- Low administrative costs
- Flexible annual contributions – good plan if cash flow is an issue
- Employer must contribute equally for all eligible employees
Simple IRA
In this plan, the employer must either match an employees’ contributions dollar for dollar — up to 3% of each employee’s compensation — or make a fixed contribution of 2% of compensation for each eligible employee.
Employees can elect to make pre-tax contributions in 2022 of up to $14,000 ($17,000 if age 50 or older; up from $13,500 and $16,500, respectively, in 2021).
Each employee who earned $5,000 or more in any two prior years, and who is expected to earn at least $5,000 in the current year, must be allowed to participate in the plan.
SIMPLE IRA plans are easy to set up and administrative costs are usually low.
Pros and Cons
- Easy and inexpensive to set up and operate
- Employees share responsibility for their retirement
- No discrimination testing required
- Inflexible contributions
- Lower contribution limits than some other retirement plans
You have a business to run. Let us help you select the plan that fits your goals.
401k
Both an employer and employee can contribute to a 401k. Employees can make pre-tax and/or Roth contributions in 2022 of up to $20,500 of pay ($27,000 if age 50 or older; up from $19,500 and $26,000, respectively, in 2021). These deferrals go into a separate account for each employee and aren’t taxed until distributed. Generally, each employee with a year of service must be allowed to contribute to the plan.
Employers can contribute to your 401(k) plan — either matching contributions or discretionary profit-sharing contributions. Combined employer and employee contributions for any employee in 2022 can’t exceed the lesser of $61,000 (plus catch-up contributions of up to $6,500 if your employee is age 50 or older) or 100% of the employee’s compensation
401(k) plans are generally required to perform somewhat complicated testing each year to make sure benefits are fair among all employees.
Pros and Cons
- There are many variation to 401K plans. This is a pro (customizable) but also a con (complicated to navigator and implement). The IRS has a useful overview of the different types of 401K plans available: https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview
Solo 401k
A variation of the 401k that is worth highlighting. This isn’t a unique plan but a 401k (and subject to all 401k rules) for a solo business owner with no employees. An employee who is a spouse is allowed too.
Business owners will sometime opt for a solo 401k over a SEP IRA because there is more flexibility in how contributions can be made. In a SEP IRA, you are only allowed to save 25% of your income, up to the $58,000 maximum. However, in a solo 401k you can contribute 100% of your income as an employee contribution (up to the normal $20,500** 401k thresholds) and then contribute at the 25 percent rate as an employer up to $61,000**.
For owner-only businesses looking to contribute a little more, and with more flexibility, a solo 401K structure may be worth exploring.
**Additional $6500 contribution possible for employees over 50
Pros and Cons
- Greater flexibility and higher contributions rates
- Moderate administrative costs
- Note: Elective deferrals are by cumulative to a person, not by plan. If a business owner is contributing to a 401k at a second job, they must consider the limit for all elective deferrals made during a year.
Defined Benefit Plans
A defined benefit plan is a qualified retirement plan that is commonly referred to as a pension. In this type of plan, the employee is guaranteed a certain benefit at retirement (for example, an annual benefit equal to 30% of final average pay). It’s the retirement benefit that’s defined, not the level of contributions to the plan. Indeed, your contributions may change each year, as a result of investment performance or other factors. An actuary is needed to calculate the annual contributions that you must make to the plan to fund the promised benefit.
In 2022, a defined benefit plan can provide an annual benefit of up to $245,000 (or 100% of pay if less).
Defined benefit plans are relatively expensive and often complex. However, they can provide the largest benefit of any retirement plan, and therefore allow the largest deductible employer contribution! For this reason, defined benefit plans can be advantageous for a business with a small group of highly compensated owners who are seeking to contribute as much money as possible on a tax-deferred basis.
Pros and Cons
- Potential to provide the largest tax-deferred contributions of any plan.
- Require and actuary to calculate yearly contributions
- relatively expensive to operate
- Best suited for highly compensated business owners with few employees
Are retirement plans expensive?
It is estimated that 90% of small business do not have a retirement plan. Some owners worry these plans will be expensive because of contributions made to employee accounts. However, E-commerce companies may have an advantage. Many E-commerce businesses have few employees, and clear ownership of the venture (as opposed to many shareholders). This structure often allows for a well designed plan to favor larger contributions going to the owners of the company (bigger tax-deferral too!) while still providing fair and measured compensation to employees (bonus: can help with employee retention and hiring).
Some retirement plans (like 401k’s or defined benefit plans) have administrations fees. The key is selecting a plan that provides far more value to the business than it costs to administer.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
About the Author
Brock Bennion, PH.D
I am a Scientist who became a financial advisor. Here’s my story:
I gravitate towards innovation and entrepreneurship. In undergrad, I co-founded a Clean-Tech company thinking that would be my career. Life is never that simple. Less than a year after graduating that company fell apart.
I felt if I had a stronger technical background, I could be a better founder. Plus, I always enjoyed Biomedical Research. So I went back to school and completed my Ph.D training in Immunology. I LOVED it!
Nothing compares to the thrill of discovery! But being a scientist is only part of my identity.
I am also a husband, father 3x, active in my church, and committed to serving in my community. I wanted a career that kept me close to science but allowed me to follow other interests as well. For me, that was helping scientists, and science-minded individuals streamline their financial life so they can focus on the things that matter most to them. Here is how I do that…
A Ph.D is different from other degrees. In a Ph.D. you are expected to create NEW information. Not just learn from a book, but figure out a gap in human knowledge, design a plan to fill that gap, and execute.
In finance, the principles are broadly applicable, but each client is different. What a specific client needs to know is not always found in a book or on google. It is sometimes a gap in human knowledge. And finding good answers, true answers, is something I am passionate about.
