Small business owners—read this!
A recent Wall Street Journal article stated that with unemployment hovering at 10 percent, about 20-23 percent of all US workers are now self-employed. If you have self-employment income or own a small company, it is important to be aware of the tax saving options available through retirement plans.
We will consider four retirement plan options available for the self-employed and small business owner. Each of the plans provides immediate tax savings on the retirement funds contributed. The retirement funds also receive tax deferred growth until the funds are withdrawn.
The simplest retirement plan is the IRA. If you have no company retirement plan and are under age 70 ½ , you may contribute up to $5,000 ($6,000 if you are over age 50) annually to a traditional IRA. If your taxable income is below $166,000, your spouse may contribute the same amount, if they have no company retirement plan. This contribution may occur even if your spouse receives no income. There are no requirements to file any company paperwork with an IRA. As long as your earned income exceeds your IRA contributions, you may continue IRA contributions until age 70 ½ .
The easiest company retirement plan, for a self employed individual, is the SEP IRA. Your annual contribution to a SEP IRA is limited to the lesser of 25 percent of your W2 compensation or $49,000 annually. SEP IRA contributions are tax deductible for the employer and excluded from the employee’s income. These plans are immediately vested and must apply equally to all employees over age 20, who have been employed for at least three of the past five years.
For high-income, self-employed individuals, a SEP IRA is often the best choice for a company retirement plan. If your income is below $50,000 or if you expect to have employees, the SEP IRA may not be your best option, as a SEP IRA requires that you provide the same percentage salary contribution for all of your qualified employees.
If your self-employment income is less than $50,000 or if you have employees, the SIMPLE-IRA is worth consideration. SIMPLE stands for Savings Incentive Match Plan for Employees. While these plans allow for up to 100 employees, most SIMPLE-IRA plans are used in smaller companies, including single employee companies.
With a SIMPLE-IRA you may contribute $11,500 ($14,000 if age 50 or over) annually. Additionally, the company pays an employee matching amount of up to 3% for each employee that makes a SIMPLE IRA contribution. If you are over age 50 and make $100,000 per year, your total contribution could be $17,000. A SIMPLE-IRA requires that your company submits a (simple) application to the custodial firm. Employees typically have the same investment options as they would with an IRA or a SEP IRA.
If you are self-employed and earn $100,000 per year or more, you can maximize your tax deferred contributions to with a Solo 401(k) retirement plan. Solo 401(k) plans are typically established through mutual fund companies, insurance companies and discount brokerage houses. These plans will have a set up fee, an annual administration fee, and other fees associated with investments and trading.
With a Solo 401(k) plan, you may contribute $16,500 of your W2 income ($22,000 if age 50 or older) plus twenty percent of your net corporate profits, up to a maximum of $49,000 ($54,500 if over age 50). As an example, if you are over age 50 and your company produces annual income of $120,000, you may contribute $22,000 plus twenty percent of your net income, for a total of approximately $40,000 in contributions, to a Solo 401(k) plan.
For the self-employed or small business owner, there is no “on size fits all” solution to retirement plans. The best plan will depend upon your annual income as well as the amount of tax deferred savings you desire to contribute each year.
If it is unclear which plan will be the best for you, feel free to contact me or call your financial advisor to determine which retirement plan best fits your requirements. Regardless of which plan you choose, it is important to start saving now for your retirement, to help insure that you will have financial abundance throughout your retirement.