It is that time of year again. The Super Bowl is over and March Madness is almost upon us and we all know what that means. Tax Day will be here before we blink an eye. You should be receiving your 1099s, 1098s and W-2’s any day now if you haven’t received them yet. Then the regret or excitement will begin to set in as you realize that you will either owe Uncle Sam or you will get a refund because you gave the IRS and interest free loan of your money.
This isn’t a post about tax planning but better yet a post about how business owners can manage their tax burden (something I hear is a priority from many business owner client I deal with) and save for your retirement at the same time.
Almost every business owner I talk to plans to one day turn their business income into a retirement income. This may be accomplished in many ways, but as I have seen on a few occasions in my career what if it doesn’t happen? What if your business doesn’t sell or sells for significantly less than you expect or worse yet somehow fails as you near retirement?
Here are 4 retirement options available to business owners:
SEP IRA
A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) allows a business owner to contribute a portion of the company profits to each employee, including themselves. These contribution limits are based on a percentage of each employee’s earned income. The maximum contribution for 2017 is $54,000 and all contributions grow tax deferred until they are withdrawn at retirement. Also all plan contributions can be taken as a tax deduction to the business, thereby lowering taxable income as well.
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA can be established by employers with 100 or fewer employees and gives each employee the option to defer a portion of their salary ($12,500 in 2017). Employees over the age of 50 can contribute an additional $3,000 per year as a catch up provision. The company is then required to match dollar for dollar up to 3% of the employee’s compensation.** As with a SEP IRA, the employer contributions and employee contributions are tax-deductible. While the SIMPLE IRA contribution limits are not as high as the SEP IRA it can be an appropriate solution for companies that have a few employees that want to save a portion of their own income towards retirement.
**Match can be lowered to 1% for two of every five years OR 2% of compensation as a non-elective contribution.
Individual 401(k)
The Individual 401(k) is designed to help ’employer-only businesses, including sole proprietors (and their spouses) save more for retirement. Contributions limits are based on a percentage of income and in 2017 the contribution limit is $54,000 with an additional allowable $6,000 if over age 50. Like a traditional 401(k) the contributions grow tax deferred until they are withdrawn for retirement, and a portion of the contributions can be used as a tax deduction for the business. One thing to keep in a mind is that the Individual 401(k) is appropriate for a sole proprietors and employer-only businesses that have no plans to add additional employees.
Defined Benefit Plan
Defined Benefit (DB) plans were very popular when I started advising clients 15 years ago. They fell out of favor prior to the financial crisis but have begun to make a renaissance of sorts. DB plans offer business owners the opportunity to save significantly more than they could with a SEP, SIMPLE or 401K. With a DB plan, the contributions are based on a projected retirement “benefit”.
Therefore, a business owner decides how much income they want at retirement (up to the 2017 benefit maximum of $215,000) and an actuary determines how much is needed to contribute to the plan each year.
DB Plan’s are a suitable savings tool for a sole proprietor or a small business owner with a few “rank and file” employees. DB Plans do have their drawbacks in that you have to contribute to them every year and can be more costly than other retirement plans to administer since they generally involve engagement of an actuarial firm to calculate the contribution amounts and for plan administration. For the right business owner though it can be a powerful retirement planning tool.
Finding the right retirement plan is critical towards solving the retirement puzzle for both you and your employees. The decision for the business owner needs to be made within the context of their goals and the businesses profitability and size.
If you own a business and need help with your retirement plan or if you are not sure you have the right plan in place. Give me a call (336-310-4233) today to schedule your free retirement review.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements and you should consult your attorney or tax advisor for guidance on your specific situation. Distributions from qualified retirement plans taken prior to age 591/2 may be subject to 10% penalty tax, in addition to ordinary income tax (25% penalty applicable for SIMPLE IRAs if distribution is within two years of participation); minimum distributions may be required at 701/2. Defined benefit plans may be appropriate for businesses with consistent revenues for long-term funding where owners are older and earn more than the average employee.