The Good, the Bad and the Ugly of Available Retirement Plans
Originally published on November 11, 2016
Updated on August 15th, 2022
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Retirement planning is becoming increasingly important, as most people can’t retire on social security benefits alone. If you’re self-employed or own a small business, however, a traditional 401k plan could be cost prohibitive or you likely don’t have the option of contributing to an employer-sponsored retirement plan. And even if you do, you might want to supplement your 401(k) savings to better finance your post-career plans.
All is not lost; here’s a quick summary of the retirement plans available to you and their income and contribution limitations.
Self-Employment Pension Plans (SEP): Contributions to a SEP plan are pre-tax. SEP plans are available to any size business, including self-employed individuals, but contributions are limited to the employer (business) only. Be aware that you must make the same salary percentage contribution for all employees (if you contribute 10% of your earnings to the plan then you must make a contribution to any eligible employees of 10% of their salary as well). This is a good option for small business owners and self-employed individuals because you have self-employed income and, therefore, are considered your own employer and qualify for a SEP plan.
You can contribute up to the smaller of $53,000 annually or 20% of net self-employment income. If you have employees, you can contribute up to the smaller of $53,000 annually or 25% of the employees’ W2 income. The start-up and operating costs are low and annual contribution amounts are flexible. In-service withdrawals are allowed but are included in your income and subject to a 10% additional tax if under the age 59 ½. These plans must be funded by April 15th of the following year, or by October 15th if on extension.
Individual 401(k): You might also hear them described as solo 401(k)s. These plans are very similar to SEP plans with a few notable differences. Both SEP and Individual 401(k) plans have the same $53,000 annual contribution limit ($59,000 if over age 50), and they’re both good for self-employed individuals and business owners without any employees (other than a spouse). There is more administration burden for an individual 401(k) than with a SEP but you add the benefits of higher contributions for a similar income and the ability to take loans (subject to IRS rules) from the 401(k) account without the 10% penalty + income taxes. Based on the difference in calculation method you can make a larger contribution to an individual 401(k) with similar income versus a SEP, so it could be a beneficial option for those looking to maximize contributions and valuable tax deductions.
SIMPLE IRAs: Contributions to a Simple IRA are pre-tax. If you are a Schedule C filer and have a Simple IRA plan, you are treated as both an employer and an employee when calculating and reporting your own plan contributions and limits. As an employee, you may make a “salary reduction contribution” up to $12,500 ($15,500 if over age 50), which must be deposited by January 30th of the following year. As an employer you must make either a matching contribution or a nonelective contribution equal to a percentage of the self-employment earnings. Employer contributions must be deposited by April 15th of the following year, or by October 15th if on extension. If you elect to contribute to a Simple IRA, it is important to note that the plan must be set up by October 1st of the tax year for which you are contributing.
Roth IRAs: Contributions to Roth IRAs are after-tax, but the withdrawals are tax-free so you don’t pay taxes on your gains. Contributions are limited to $5,500 per year, or $6,500 if you’re older than 50. Unfortunately, there are income limitations to this plan; joint filers must make $183K-$193K/year or less, and single filers must make $116K-$131K/year or less in order to contribute. These plans must be funded by April 15th of the following year.
Traditional IRAs: Contributions to traditional IRAs are pre-tax but withdrawals are taxed, so you pay taxes on any gains but get the income deduction this year. Similar to the Roth IRA, you can contribute up to $5,500 each year or $6,500 if you’re age 50 or older. If you participate in an employer-sponsored retirement plan, the income phase out for traditional IRAs is $98-$118K/year if filing jointly and $61-$71K/year for single filers. If you don’t participate in a work-sponsored retirement plan but your spouse does, then the income phase-out for a traditional IRA is $183K-$193K/year if filing jointly. If you are single and don’t participate in an employer-sponsored retirement plan, or if you are married and you and your spouse don’t participate in an employer-sponsored retirement plan, there is no income limitation. These plans must be funded by April 15th of the following year.
There are no income limitations on non-deductible traditional IRA contributions, and there are planning opportunities to potentially roll over a non-deductible traditional IRA contribution to a Roth IRA to get around the income limitations noted previously. However, there are some exceptions.
Do you have questions regarding what plan is good for you and your business? Contact the Avantax Planning Partners through James Moore, CPAs today to learn about social security benefit planning, retirement planning and asset management services.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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