Small business retirement plans offer a combination of tax advantages and wealth-building potential that every law firm owner should, at the very least, consider. But where should you start when it comes to implementing a plan?
Table of contents
Let’s first explore how implementing a retirement plan can strengthen your firm’s future. Then, I’ll break down the specific retirement plans available to help you choose the right option for your practice.
Why Your Firm Should Consider a Retirement Plan
Benefit No. 1: Building Long-term Wealth
The most obvious benefit of implementing a retirement plan is the ability to build substantial wealth for your future. Unlike personal individual retirement accounts (IRAs) with relatively low contribution limits, business retirement plans allow you to set aside significantly larger amounts each year. Don’t get me wrong, IRAs serve their purpose. The good news is that the contribution limits allocated to IRAs are separate from those of a retirement plan. In other words, you can maintain and contribute to both a Roth IRA and a traditional 401k, for example.
However, the increased limits of most small business retirement plans can accelerate savings and help you build a robust retirement portfolio more quickly.
Moreover, these plans aren’t just about retirement. They can serve as a powerful wealth management tool, allowing you to diversify your investments and create a financial safety net separate from your firm’s value. This means building passive wealth that doesn’t require your input to your law firm.
Benefit No. 2: Tax Advantages: More Than Meets the Eye
The tax benefits of business retirement plans are substantial and multifaceted. First, contributions to employee retirement accounts, including your own, qualify as tax-deductible business expenses, immediately reducing your firm’s taxable income.
Additionally, employer contributions are exempt from FICA taxes (Social Security and Medicare taxes), providing your firm with a 7.65% savings on each dollar contributed — an often-overlooked benefit that can result in significant savings over time.
Another critical advantage is tax-deferred growth, where your investment earnings grow tax-free until withdrawal, allowing your investments to compound more efficiently.
Next, retirement account contributions can help reduce your income to qualify for the Qualified Business Income (QBI) deduction. Law practices face special QBI deduction limits as a specified service business. While high income may reduce or eliminate the deduction, strategic tax planning can help you qualify for partial benefits, if not the full deduction.
Beyond these ongoing tax advantages, small businesses can qualify for tax credits of up to $5,000 during the first three years to help offset retirement plan setup costs. Taken together, these tax benefits make retirement plans a powerful tool for managing your firm’s tax burden while building long-term wealth.
Benefit No. 3: Employee Recruitment and Retention
Beyond the tax advantages, a robust retirement package helps attract top legal talent in a competitive market and encourages long-term commitment from associates. These benefits support stronger client relationships and preserve valuable institutional knowledge by reducing turnover while demonstrating the firm’s commitment to its employees’ long-term financial well-being.
For younger attorneys, retirement benefits can be a key differentiator when choosing between firms, making them an essential component of a comprehensive compensation package.
Understanding Your Plan Options
Let’s explore the most common retirement plan options for law firms, each with its own advantages and considerations.
SEP IRA
Due to its simplicity and flexibility, the simplified employee pension (SEP) IRA can be an attractive choice among smaller firms.
Key Features:
- High contribution limits (up to $69,000 in 2024). However, one thing to note here is that contributions are limited to 25% of total compensation or $69,000, whichever is less.
- Easy setup and minimal administrative costs.
- Flexible annual contributions.
- No annual filing requirements.
Considerations:
- The employer must contribute the same percentage for all eligible employees.
- Only employer contributions are allowed.
- Best suited for firms with few employees or solos, as a lot of law firm owners will not want to contribute the same percentage for employees as they do for themselves.
Solo 401(k)
The Solo 401(k) offers maximum contribution potential for firms with no full-time employees except owners and their spouses.
Key Features:
- Highest possible contribution limits through combined employer/employee contributions ($69,000).
- Loan provisions available.
- Can include spouse working in the business.
- Can allow for both traditional and Roth contribution options.
Considerations:
- Limited to businesses with no full-time employees beyond owners and spouses.
- More complex administration than SEP IRAs.
- Annual filing requirements when assets exceed $250,000.
SIMPLE IRA
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is designed for smaller businesses with up to 100 employees.
Key Features:
- Easier administration than a traditional 401(k).
- Both employer and employee contributions allowed.
- Good for firms with multiple employees.
- No annual filing requirements.
Considerations:
- Lower contribution limits than SEP IRAs or 401(k)s ($16,000 in 2024).
- Mandatory employer contributions, so predictable cash flow is important here.
- Early withdrawal penalties may be higher than other plans.
Traditional 401(k)
While more complex to administer, a traditional 401(k) offers maximum flexibility and features. Just as trusts are governed by their trust documents, a 401(k) can be customized to the needs of the business. While this sounds most appealing in theory, these plans will carry more administrative burdens than some of the options mentioned above.
Key Features:
- High contribution limits ($69,000 in 2024).
- Flexible plan design options (including various employer matching structures).
- Loan provisions.
- Roth options available.
- Good for firms of any size.
Considerations:
- Typically higher administrative costs.
- Annual testing requirements.
- Required annual filings.
Making the Right Choice
Selecting the right retirement plan depends on several factors:
- Your firm’s size and growth plans.
- Number of employees.
- Your desired contribution levels.
- Administrative complexity tolerance.
- Cost considerations.
Many law firm owners find that their needs evolve. Starting with a simpler plan like a SEP IRA or SIMPLE IRA and transitioning to a more robust option as your firm grows is often a sound strategy.
Next Steps for Setting Up a Small Business Retirement Plan
Is a small business retirement plan the right move for your law firm? Consider consulting with a financial advisor who focuses on small business retirement plans for law firm owners to determine which option best suits your firm’s needs and goals. The tax savings and wealth-building benefits make this one investment in your firm’s future that deserves some consideration.
Remember, as a law firm owner, you spend your days helping clients protect their interests and plan for the future. Make sure you do the same for yourself and your employees through a well-designed retirement plan.
Read David Hunter’s article “Attorney Financial Planning Made Simple: 4 Vital Signs.”
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